* USD to weaken in 2016. We believe the USD will weaken in 2016, in contrast to a consensus
that expects the USD rally to extend. History shows the USD weakens once the Fed starts to
hike rates. In addition, we believe the conversation about the pace of Fed hikes will retain a very
dovish tone in 2016, mirroring the experience of other central banks which have tried to raise
rates after the 2008/09 financial crisis.
* ECB will not be able to engineer a fresh bout of EUR weakness. The ECB faces constraints
on how much it can expand QE, both in terms of the amount of bonds available to buy, and
internal support for further monetary easing. Better than expected Eurozone data is also a
challenge to a market still short EUR.
* The JPY may strengthen as the BoJ is unlikely to expand QE further in 2016. Like the ECB,
the BoJ’s QE programme is reaching its limit, and we believe the central bank will move to a
rates-based policy framework in 2016. In any event, the pressure for additional easing is on the
wane given the BoJ’s focus on the new (and higher) core inflation measure.
* GBP to strengthen before succumbing to ‘Brexit’ fears. The market no longer expects the
BoE to raise rates in 2016. We disagree, believing a rate hike in May is likely. The re-pricing of
rate expectations should help push GBP higher early in the year towards 1.60 for GBP-USD.
An intensification of the Brexit debate will likely raise fresh concerns about the sustainability of
the UK’s sizeable current account deficit causing GBP to weaken afresh.
* Canada’s fiscal experiment could be a game changer for the CAD. Although the currency
will remain beholden to the vagaries of the oil price, other factors argue the currency could
strengthen later in 2016. Chief among these is the prospect of some fiscal stimulus at a time
when monetary policy and currency war gains are nearing exhaustion. We forecast USD-CAD at
1.25 by the end of 2016.
We expect the pace of EM FX weakness to ease in 2016 as the adjustments already made in
currencies mean more of the risks are priced in. Commodity prices have already fallen a long
way, thereby posing less of a threat going forward. Also EM FX should not fear a gradual Fed
hiking cycle. Nonetheless, there is still not a convincing case for a significant EM FX recovery in
2016 given a meagre EM growth outlook, China risks, high EM leverage and local frailties.