2016 – Four quarters equal a strong dollar
FX Consultant / IFXA Ltd
· Q1 2016 volatility was a trader’s dream
· Fed rate hike theme, Brexit and oil dominated 2016
· Running with the herd can be an expensive trading strategy
This might look like fun. But it’s dangerous. Pic: iStock
By Michael O’Neill
The first quarter of 2016 was ushered in with a dazzling pyrotechnic display in cities around the world. However, it was the Chinese fireworks show that stupefied world financial markets.
A major melt-down in Chinese equity markets unleashed a torrent of fear and loathing in Las Vegas and across global markets on January 4, 2016. The Shanghai Shenzhen CSI 300 Index dropped 7% before circuit -breakers tripped and ended trading for the day. Weaker than expected Chinese data was one of the main catalysts for the move. The Peoples Bank of China fixed CNY at 6.5032, the highest level since 2011. That was a big deal then but as USDCNY flirts with 7.00, it looks like a bargain.
The damage wasn’t contained to China. The Japanese yen was bought as a safe haven and the risk-off theme spread into Europe. European equity indices tanked as did the Dow Jones Industrial Average. The US dollar roared higher with only the yen and Swiss franc posting a gain. And all that was on day one.
It got worse. China’s equity market circuit breakers triggered again and were abandoned. Oil prices plummeted with WTI hitting $26.78. CNN reported that the Dow Jones Industrial Average had its worst 10-day start to the year since 1887. The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) spiked to 32.19. There were no shortage of doom and gloom predictions.
Chart: Dow Jones Industrial Average January 2016
Source: CNN Money
But a funny thing happened on the way to the forum and the end of the world. It didn’t happen. By the end of January, another 6.4% plunge in the Shanghai Composite Index was shrugged off by equity traders elsewhere. The major indices clawed back losses, although with a lack of conviction which proved prescient in early February. Oil prices also rallied, gaining 30% from the low on rumours that Opec would make production cuts, a rumour that proved true 11 months later. The Bank of Japan cut rates into negative territory and the Federal Open Market committee delivered a somewhat dovish statement. The European Central Bank left rates unchanged but bank chief Mario Draghi opened the door to additional policy action in March.
February ushered in the Year of the Monkey and another unchanged rate decision by the Reserve Bank of Australia. A fresh batch of oil production cut rumours lifted oil from a low of $26.06 and kicked off a 3½ month rally. That rally helped USDCAD retrace 0.1100 points from its January peak. February was also the month when “Brexit” chatter became a daily event for sterling. GBPUSD got smacked when news that the EU and the UK agreed to a new deal which set the stage for a June 23 referendum in Britain. China sacked the head of the securities regulating agency in an attempt to put the earlier equity market woes behind them.
A series of mixed US economic data releases raised questions about the prospect of the Fed’s March rate increase which had been forecast by the December dot-plot data. The G20 meeting in Shanghai ended the month. The PBoC governor told a press conference that there was no reason for CNY to fall persistently. The USDCNY fix on February 26 was 6.5436
The Fed rate hike in March never materialised and the somewhat dovish statement gave US equities a new lease on life. Donald Trump, a mere Republican presidential nomination candidate, called China a currency manipulator. It was no big deal then but come January 20, 2017, things could change.
The second quarter of 2016 did not start with financial market fireworks. Instead, it ended that way.
Oil prices tracked higher until mid-June on anticipation of Opec production cuts. A dovish Fed and becalmed China equity markets helped US equities recover from the Q1 debacle. They got an added boost from an upgraded GDP outlook in May. Eurozone equity indices didn’t fare as well. The diverging US/Eurozone interest rate paths and economic outlooks drove EURUSD from a peak of 1.1605 to 1.1110 in by the beginning of June. That also fuelled expectations that the FOMC would raise rates at their June meeting. They didn’t. The looming UK referendum on EU membership spooked them. They were concerned about market volatility in the event that the “leave” side prevailed. They nailed that one.
Britain’s decision to exit the EU reverberated across asset classes and set the tone for the summer. GBPUSD was at 1.500 as the results were being tabulated and finished the quarter at 1.3270. EURUSD dropped to 1.0933 from 1.1425 but closed out the month at 1.1165.
Chart GBPUSD around Referendum
Source: Saxo Bank
The third quarter offered a respite from the turmoil and volatility in the first six months. EURUSD was range-bound with a 1.0940-1.1360 band. Britain got a new prime minister, Theresa May, who took over from David Cameron. She is tasked with cleaning up his mess. GBPUSD bounced within a 1.2780-1.3470 range although short positions stayed at extreme levels and Brexit issues dominate trading. The Fed’s decision to leave rates unchanged signalled, to many, that it was “lower rates for longer”. US equities continued their march higher. Eurozone equity indices also eked out gains and Japan’s Nikkei rose 7.1%. Even UK stocks climbed, helped by easing measures from the Bank of England.
Fed chair Yellen was guilty of stoking rate hike hopes when she told attendees at the Jackson Hole Symposium in August, that the case for a rate hike had “strengthened”. Those hopes were dashed in September when rates were left unchanged.
Quarter four was all about the US election, Opec and the expected Fed rate hike in December.
USDJPY climbed relentlessly and EURUSD dropped steadily. Sterling cratered on October 6. A “panicked”Citibank trader in Tokyo was taggedfor exacerbating a drop in GBPUSD from 1.2860 to 1.1500 in about 40 seconds. When the dust settled and traders realised that Mars was not attacking, sterling bounced. However, it was not until the middle of December before GBPUSD recovered all the Tokyo losses.
Readers of the New York Times or Washington Post were smug in their knowledge that Hillary Clinton would become the first woman and 45th president of the United States. The problem was that a lot of American’s didn’t read those papers. Donald Trump won. US equity markets and the US dollar have rallied ever since.
Oil prices were on a roller coaster until the last day in November. Traders were sceptical of Saudi Arabia’s ability to garner enough support to achieve meaningful production cuts. Oil prices had declined from $49.15 on November 22 to $44.80 the day before a deal was to be announced. The Saudis prevailed. Oil soared and WTI hit $54.34 after Christmas.
Mario Draghi and the European Central Bank muddied the waters when they announced that they would reduce the amount of bonds purchased each month. Then they added another nine months to the quantitative easing program. Traders whipped out their calculators, quickly determined that the extension amounted to an increase in quantitative easing and sold EURUSD.
The final FOMC meeting of the year was almost anticlimactic. Almost. By the time Janet Yellen and company announced a 0.25 basis point increase in the overnight Fed funds range, it was 97% priced into the market. The excitement arose from three rate increases projected in the dot-plot forecasts for 2017. The September dot-plot forecast only had two. Once again, the US dollar was off to the races.
The US dollar is closing out the year on a mixed note. Sterling is the biggest loser followed by the euro, Swiss franc and Australian dollar. The Japanese yen, Canadian dollar and New Zealand dollar squeezed out gains.
If we learned anything from 2016 it is that if you always run with the herd, you risk getting trampled. Conventional wisdom isn’t wisdom, just conjecture dressed up as conviction.
— Edited by Clare MacCarthy
Michael O’Neillis an FX consultant at IFXA Ltd.