The year 2015, no doubt, has been a year to remember. Markets saw the first Fed rate hike in years which pushed the Dollar ever higher. In the Eurozone, the ECB's QE pushed the Euro to lows it hasn't seen in years. And in China, the Yuan, too, is being pushed to record lows as China's economy gets squeezed.
Now, with 2016 practically knocking at the door, the question is will 2016 be the year of a turnaround? Or will the themes of 2015 continue to dominate? Here are some major areas to focus on which can help us figure it all out.
China And The Yuan
The first priority of our focus is, of course, China and its policy on the Yuan. As recently as this past week, the PBOC curbed some of the Yuan's value. Overall, however, the Yuan seems to still be under pressure as the Chinese economy falters. The question for the PBOC is when will enough be enough in terms of Yuan weakness?
Back on August 11th, we estimated that the Yuan was at least 7% overvalued. That meant that a minimum 7% devaluation of the Yuan against the Dollar was needed. Theoretically, that would allow the Chinese economy to reheat again and ease pressure on manufacturers. Since the PBOC began weakening the Yuan back on August 10th, the Yuan has depreciated by roughly by 3%.
Over the same period, the Dollar's value, as indicated by the US Dollar Index, remained essentially flat. At the very least, that leaves another 4% to rollback the Yuan's gains to before August 2015 which have weighed on the economy. Considering most Chinese indicators are still weak, we can assume that, indeed, Yuan weakness is not finished. Certainly, that weakness could continue into the second quarter of 2016.
The ECB And The Euro
In many aspects, the Eurozone and China are in a similar situation. Both need a weaker currency to support their export-oriented economy and both have a deleveraging banking sector. The difference, however, is that, at least in the short term, Europe's economy may take longer to turnaround. That's because Europe's labor costs are still rather high. That, of course, makes it harder for Europe to compete. Moreover, while inflation has stabilized in China in Europe it's still depressingly low. And, unlike China, the Eurozone is pretty much stagnant in its economic performance.
Given all that, it's a long way to go for the Euro to come down. The initial start would be for the Euro to drop below parity. Yet even so, that's not a guarantee that inflation will be back in the Eurozone. For that to happen, Eurozone banks need to have stronger balance sheets to step up credit growth. That will turn the economic wheels of the Eurozone faster. Until then, however, the pressure on the Euro is destined to continue.
Fed To Continue And Tighten?
It is rather likely that the Fed will tighten at least two times. However, unlike the Eurozone or China, in the US the credit system is working well. Credit is flowing which leaves plenty of room for inflation to rise, even if only moderately. If, Oil does indeed bounce back through 2016, higher prices might translate into higher inflationary readings. And higher inflation could lay the groundwork for three or even four rate hikes next year.
When To Be Dollar Prudent?
Among the current conditions, it seems that the trends of 2015 of stronger Dollar and weaker everything else is set to continue. That's very likely through the first quarter of 2016 and perhaps even the first half of the year. However, beyond six months, there's greater uncertainty. If the ECB expands its QE and if the Yuan falls further to more competitive levels, then economic green shoots could emerge in those two economies. And when that happens profit taking could hit the Dollar. Until then, however, despite high hopes, it seems the investment themes that dominated FX in 2015 are set to continue.
Look for my post next week.
INO.com Contributor - Forex
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.