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Annual Forex Market Outlook – 2016

By:
James Hyerczyk
Updated: Dec 26, 2016, 12:10 UTC

2016 started out with the main focus on the U.S. Federal Reserve. It had just raised rates in December 2015 for the first time in 10 years to 0.50%. It

Annual Forex Market Outlook - 2016

2016 started out with the main focus on the U.S. Federal Reserve. It had just raised rates in December 2015 for the first time in 10 years to 0.50%. It was also forecasting that FOMC members expected rates to be between 1.25% and 1.5% at the end of 2016, or around four rate hikes.

2016-monthly-cash-u-s-dollar-index
US Dollar Index – Monthly Chart
  • As of December 23, the cash U.S. Dollar Index was trading 102.97, up 4.34 or +4.40%.
  • After forecasting as many as four rate hikes in 2016, the Fed reduced the number to one.
  • The Fed postponed rate hikes several times in 2016 for various reasons including concerns of China’s economy, global economic peril, Brexit and the U.S. presidential election.
  • The majority of the dollar’s gains came after the November 8 election of Donald Trump.
  • The late rally was fueled by a sharp rise in U.S. Treasury yields that were fueled by Trump’s promise of a huge fiscal spending, a 25-basis point rate hike by the Fed in December and its projections for at least three rate hikes in 2017.

Although the U.S. Dollar is expected to finish the year near a 14-year high, we cannot expect to see the same spectacular gains we’ve seen during the last two months of 2016. This is because there is no guarantee the Fed will raise rates three times in 2017 and Trump will get everything he wants including $1 trillion to rebuild America, tax cuts, new trade deals and some deregulation measures.

EUR/USD

The Euro started 2016 with a strong rally that lasted until May. The driving force early in the year was the weaker U.S. Dollar, and the Fed’s reluctance to raise interest rates. As of December 23, the EUR/USD was down 0.0403 for the year or 3.71%.

2016-monthly-eurusd
EUR/USD Monthly Chart
  • On March 10, the European Central Bank also unleashed a bigger than expected package of measures aimed at stimulating the Euro Zone economy, with expanded quantitative easing, incentives to banks to increase lending and further interest rate cuts.
  • The Euro reached its high for the year on May 3 at 1.1616 after the European Commission told the Euro Zone’s largest economies to reduce debt and modernize labor markets as it again slashed its inflation forecast and warned of slower-than-predicted growth across the 19-nation bloc.
  • The Euro continued to weaken in June as German 10-year Bunds slipped below zero percent. Then on June 24, the U.K. voted to leave the European Union in a move that became known as Brexit.
  • After drifting sideways for several months, volatility returned with the surprise election of Donald Trump as President of the United States. A rapid rise in U.S. interest rates helped drive the EUR/USD sharply lower.
  • The Euro further accelerated to the downside in December after the ECB decided to trim its massive monthly bond-buying program beginning in April. Investors had expected the central bank to extend its program of buying public and private Euro Zone debt at its present pace of 80 billion Euros for most of 2017.

In 2017, rising U.S. interest rates are expected to continue to exert pressure on the EUR/USD with the market likely to reach 1.0000 or lower, depending on the volatility. Unless the ECB changes policy to extend its program of buying debt, the divergence between the policies of the ECB and the Fed is going to favor the U.S. Dollar.

GBP/USD

The British Pound lost 16.64% of its value against the U.S. Dollar in 2016 and 15.51% versus the Euro as the U.K.’s decision to vote itself out of the European Union in June weighed heavily on market expectations for Britain’s economy.  This became known as Brexit.

2016-monthly-gbpusd
GBP/USD Monthly Chart
  • After the initial plunge from 1.5016 to 1.2791, the GBP/USD consolidated for two months as the Bank of England stepped in to support the economy. On August 4, the Bank of England said that it would cut its main interest rate to its lowest level ever and expand other measures to bolster Britain’s economy over concern that the country’s decision to leave the European Union could weigh on growth.
  • The GBP/USD was hit hard again on in early October, plunging as low as 1.1739 in extremely volatile trading. On October 2, U.K. Prime Minister Theresa May announced a timetable for Britain to leave the EU in the Spring of 2019. Immigration was at the center of her strategy for withdrawal, suggesting that Britain could be headed for a “hard Brexit,” or clean break from the Union.
  • In a speech May said Britain would trigger Article 50, or formally begin exit negotiations by the end of March. She also said the talks would be governed by a two-year deadline unless all members of the bloc agree to prolong them.

We expect to see more sideways price action in early 2017 but then a pick-up in volatility as we approach the end of March. Due to the uncertainty over the Brexit negotiations and the length of the negotiations, we see further downside pressure emerging with the first downside target zone 1.1700 to 1.1400. This is followed by 1.0520.

USD/JPY

The U.S. Dollar lost ground to the Japanese Yen in 2016, but most of that loss occurred between January and June. From July to early November, the USD/JPY consolidated, but since November 9, the Forex pair has gone on a tear. It is likely to finish the year about 2.35% lower, however, the momentum into the end of the year suggests it is going to rally early in 2017.

2016-monthly-usdjpy
USD/JPY Monthly Chart
  • The USD/JPY reached its peak in 2016 at 121.678 on January 29. From there, it proceeded to trend lower until finally bottoming on June 24 at 98.887. This was the same day that the U.K. voted to leave the European Union.
  • The selling pressure during the first half of the year was primarily related to the carry trade. Weaker equity markets encouraged investors to seek shelter in lower yielding currencies like the Japanese Yen. Furthermore, it looked as if the Bank of Japan had run out of weapons to stimulate the economy and weaken its currency.
  • After consolidating for several months, the USD/JPY rallied from 101.179 on November 9 to 118.658 on December 15. The steep rally was primarily driven by rapidly rising U.S. Treasury yields on the heels of economic promises from president-elect Donald Trump. The Dollar/Yen was further supported by a Fed rate hike and the forecast for three more hikes in 2017.

The USD/JPY is likely to ride the end-of-the-year momentum into 2017 with a possible surge to 125.00 early in the year. This is possible because investors are going to give Trump the benefit of the doubt that his economic proposals will help grow the U.S. economy.

AUD/USD

After spending most of the year higher, the Australian Dollar gave back all of its earlier gains to finish the year lower against the U.S. Dollar. As of December 23, the AUD/USD was trading .7174, down 0.0109 or -1.49%.

2016-monthly-audusd
AUD/USD Monthly Chart
  • Because of the favorable interest rate differential, the AUD/USD traded higher during the early part of the year. Although the Reserve Bank of Australia was trying to stimulate the economy through a series of interest rate cuts, the currency remained strong because the Fed kept postponing its interest rate hikes in 2016.
  • The RBA made its last interest rate cut on August 3. At that time, it reduced its benchmark rate 25 basis points to 1.50 percent. For the next several months, it hinted that it may be finished with its reducing cycle. However, certain economic events near the end of the year, suggest the RBA may have to make at least one rate cut in 2017.
  • The year ended with the RBA flagging the prospect of a near-term slowdown in economic growth, noting that “some slowing in the year-ended growth rate is likely, before it picks up again”. The RBA was likely talking about the Q3 GDP report that showed the Australian economy contracted for only the fourth time in the last 25 years. Furthermore, investors will be going into 2017 concerned over whether Standard & Poor’s will reduce the country’s triple A credit rating.

The downside momentum at the end of the year suggests the selling will continue into 2017. It could accelerate further if problems arise in housing, labor or economic growth. If this is the case then the RBA will be forced to cut rates while the Fed is raising rates, putting further pressure on the Aussie.

Emerging Markets

The election of Donald Trump as president had a negative effect on two major emerging market currencies – the Chinese Yuan and the Mexican Peso. The USD/CNY closed on December 23 at 6.95292, up 0.38580 or +5.87% and the USD/MXN finished at 20.5881, up 3.4171 or +19.90%.

2016-monthly-usdcny
USD/CNY Monthly Chart
  • The divergence between the policies of the People’s Bank of China and the U.S. Federal Reserve helped underpin the USD/CNY. Rapidly rising U.S. Treasury yields were also behind the strength. However, the biggest threat to China is Trump’s economic policies and plans to challenge what he considers to be unfavorable trade agreements. Furthermore, Trump has accused the Chinese of currency manipulation.
  • The USD/CNY is likely to continue to be underpinned by the favorable interest rate differential in 2017, but the real volatility could stem from China’s reactions to Trump’s policies.
2016-monthly-usdmxn
USD/MXN Monthly Chart
  • The Mexican Peso lost ground against the U.S. Dollar in 2016 with most of the loss coming from Trump’s surprise win. This is because of Trump’s campaign promise to rework trade agreements and to build a wall between the U.S. and Mexico to prevent illegal immigration. The USD/MXN could rally further in 2017 if Trump has his way.
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About the Author

James is a Florida-based technical analyst, market researcher, educator and trader with 35+ years of experience. He is an expert in the area of patterns, price and time analysis as it applies to futures, Forex, and stocks.

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