The first quarter of 2016 has ended and March has faded to a memory. March, like February and January before it, never unfolded the way most traders/strategists predicted and only a fool will believe that April and Q2 will be any different. If variety is the spice of life, volatility is the hot sauce of FX.
When the calendar turned over to 2016, the financial markets were convinced that the Federal Reserve would hike interest rates at least four times in 2016, in part because that is what the Federal Open Market Committee (FOMC)members were indicating via their dot-plot forecasts. That sentiment started taking hits when the Chinese equity markets melted down in the first few days of trading and FX markets had an under-whelming reaction to a block-buster US employment report. Canadian traders, or at least half of them, were convinced that the Bank of Canada (BoC) would cut interest rates and oil prices were sinking. By the middle of the month, fears of another financial apocalypse were rampant.
FX commentators and pundits were busy warning of the imminent decline of the global economy and some were warning of a 2008 style financial collapse. And as they were talking and preparing their doomsday forecasts, the world changed. The second ½ of January sparked a Canadian dollar rally, the likes of which hadn’t been seen since February 2009. The Loonie wasn’t the only currency rallying. The commodity bloc currencies soared as did yen and EURUSD.
It took a while but by mid-February, traders were starting to believe that, although the markets were still in a tunnel, the light they were seeing was not a train, but daylight. New York Fed president, William Dudley, hinted that US rates weren’t going anywhere in March and EURUSD soared. However, when core US CPI data jumped to its highest level since June 2012 and European Central Bank (ECB) President, Mario Draghi, promised that the central bank “was ready to do its part” and “won’t hesitate to act”, the EURUSD rally ended and US dollar bulls took control against the G10 currencies. The Canadian dollar was the exception. It was strengthening on rising oil prices. Russia and Opec announced plans to meet to discuss a production cap and that news had oil bears scurrying to cover positions.
March roared in with FX traders reacting rather strangely to the nonfarm payrolls report. The headline number was strong and handily beat forecasts but this time, it was the average hourly earnings (AHE) component that got the attention. The AHE decline caused a decrease in the number of rate hikes expected. Mario Draghi delivered what he promised. By many accounts, the new ECB stimulus package exceeded expectations and EURUSD tanked. Mario was indeed super. But that didn’t last long. When he said that he didn’t anticipate further rate cuts, EURUSD soared and no one was calling Mr. Draghi “super” anymore.
The Fed meeting, in the middle of March, provided another kind of drama. Prior to the FOMC, a series of steadily improving US economic releases, the rebound in commodity prices and a number of Fed speakers had markets anticipating a hawkish-leaning Fed. No one expected a March rate hike but an April move wasn’t out of the question. Unfortunately, no one had talked to Janet Yellen. The FOMC statement and Ms. Yellen’s press conference were doveish while the dot-plot rate forecasts shrank to just two hikes in 2016 from four in December. The US dollar got hammered and the Canadian dollar rallied.
The following week was peppered with a number of Fed speakers and they were singing a different tune. St Louis Fed President, James Bullard was suggesting that rate hike may not be far off. Atlanta Fed President, Dennis Lockhart, said he saw scope for three rate hikes this year.
FX markets started to drink the Kool-Aid. Perhaps, they misjudged. Maybe Janet Yellen’s doveish message wasn’t really doveish at all. The US dollar started to creep higher ahead of Ms. Yellen’s speech to the Economics Club of New York on March 29. And as Britney Spears famously sang “Oops, I did it again”. Dollar bulls got crushed and proved once again, that FX markets have a mind like a sieve.
What did we learn from the market action in Q1 2016? It is readily apparent that the direction and timing of US interest rate moves are as dominate a factor in FX trading as they were last year. And that isn’t going to change any time soon
Traders will be waiting for signs that the Fed will hike rates and it appears that an April move is unlikely. Futures traders see a 6% chance of a rate hike in April. It rises to 31% in June, 44% in July and 54% in September. The probability of a December rate hike sits at 70%
Oil price uncertainty has bubbled back to the surface and a decline in oil prices was cited by Janet Yellen as a major reason for her cautious stance. Saudi Arabia Deputy Prince Mohammed bin Salman told Bloomberg on Wednesday that his country would not cap production if Iran doesn’t. Iran has stated time and again that it has no interest in production caps until it is pumping crude at pre-sanction levels. The other immediate price issue is that production continues to exceed supply and even if non-Opec and Opec nations reached a price support deal, it wouldn’t do anything to curb the existing oil glut.
China is another wild card. Chinese officials are trying to engineer a “soft landing” or at least prevent a “hard-landing becoming a “splat”. S&P cut China’s outlook to negative from stable on Thursday. Massive China equity market weakness got global markets off on the wrong foot in January and markets are still nervous. FX traders remain wary of the destabilizing effects of CNY devaluations which created a rash of volatility, once in august 2015 and again in January 2016.
The UK’s Brexit vote in June will be a nasty event for Britain, EURGBP, GBPUSD and GBP/crosses as well as possibly destabilizing the Eurozone and EURUSD.
Q2 market action may not be a whole lot different than Q1, mainly because none of the Q1 issues have been resolved. The oil market will remain choppy until the results of the April 17 meeting are known and then depending upon the result, will help or hinder commodity bloc currencies. US economic data reports and various Fed speakers will keep US rate direction front and center and FX markets volatility will remain elevated.
David Marks, Agility FX Analyst
