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    Taking stock of 2016 in foreign exchange

    The first 7 trading days of 2016 have featured some very significant moves in currencies and other financial markets.  The two main themes that appear to be driving markets are the weakness in the Chinese stock market and the currency (the yuan) as well as fresh record lows in the price of oil.  Oil for example has already fallen by around 20% since the beginning of the year and is now challenging the $30 a barrel level – the lowest in more than 12 years.

    The clearest implication has been that commodity and emerging market currencies have taken a fresh beating, adding to their woes after a very challenging 2015.  Therefore, it has been more of the same for currencies such as the South African rand, the Russian ruble and the Brazilian real.  In developed market currencies, the Canadian dollar has also fallen to fresh 12 ½ -year lows, as Canada is an oil exporter.  Other developed country commodity exporters that have seen their currencies losing serious ground are the New Zealand and Australian dollars – down by more than 4% since the beginning of the year against the US dollar.  The antipodeans’ close trade relationship with China has made them more vulnerable to the market turmoil and growth fears surrounding the world’s second largest economy.

    On the other side, the main winner since the beginning of the year has been the safe haven Japanese yen.  Dollar / yen and euro / yen are down by a little more than 2% since the beginning of the year, as traders flock into the safe haven yen during turmoil.  The Swiss franc – another safe haven play – has also lost ground against the yen, as the swissie has more or less kept up with the US dollar and the euro and not fulfilled its traditional safe haven role.  Strangely, euro / dollar, the world’s most traded currency pair, has done little this year as it looks more or less directionless despite the volatility.  It appears that current EURUSD levels seem to reflect both the worries that market and economic uncertainty could dissuade the Fed from raising rates too fast in 2016 as well as the ECB’s reluctance to augment the size of its monthly asset purchases.

    The other loser that was perhaps a surprise for consensus expectations has been the pound.  Sterling has of course held up better than the commodity currencies, but its retreat against the euro and the dollar has led to the breach of some important levels.  Against the dollar in late 2015 it had already decisively broken out of the 1.50-1.60 range it held for most of the previous 13 months or so.  It then proceeded to make a fresh 5-year low in the New Year below 1.45.  In euro / pound, the key 0.75 pence level was taken out, leading to a 1-year high.  There haven’t been any major fundamental news for the UK pound, but some concern regarding the in / out referendum for EU membership, expected renewed dovishness from the Bank of England following the deflationary impact of even weaker oil prices and worries that financial market turbulence could affect the country’s big financial sector are some of the factors that the market is focusing on.

    To sum up, the consensus expectation right now is probably that the Chinese problems will not spread and that they will be contained or kept under control by the authorities there (as happened after the similar August crisis last year).  If this happens, the yen is likely to give up some of its recent gains.  Gold by the way has done even better than the yen (up by more than 3% year-to-date) and any stabilization will likely lead the yellow metal back to its long-term downtrend.

    Things are less straight forward for emerging and commodity currencies as global economic growth will likely remain weak and it is premature to say that the commodities down cycle has ended.  They could stabilize nevertheless and post some modest gains if risk appetite also recovers before resuming their downtrend.

    There is also the risk that Chinese authorities, if they are unable to stem capital outflows from the country, could let the yuan drop even faster.  This could make the current turmoil more severe and of course help safe haven plays gain even more.  Even if this is not a consensus call, traders should nevertheless be prepared for extreme scenarios and even higher volatility when designing their trades, since if the first few days of the year are any indication, there should be some serious volatility ahead during 2016.

    Risk Warning: Forex, Commodities, Options and CFDs (OTC Trading) are leveraged products that carry a substantial risk of loss up to your invested capital and may not be suitable for everyone. Please ensure that you fully understand the risks involved and do not invest money you cannot afford to lose. Please refer to our full Risk Disclosure.

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