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Article / 01 July 2016 at 15:00 GMT

Lions and dragons and doves, oh my!

FX Consultant / IFXA Ltd
  • US independence day Monday makes for short trading session today
  • First half of 2016 was a 'World of Odd', culminating with the Brexit shock
  • Sterling the only losing currency in H1 2016
  • Volatility will burn out, not fade away, in H2 2016

Trafalgar Square, London
The lions of Trafalgar Square keep calm and carry on despite 
the mayhem of the first half of 2016. Photo: iStock

By Michael O'Neill

The first half of 2016 was definitely, a “World of Odd”. Traders were heard muttering to themselves, “Lions and dragons and doves, oh my”. The Lions (England and the UK) flayed FX markets throughout the end of the period. The dragons (China) flamed markets at the start of the year, while the doves (Yellen) flew overhead, worrying markets in the middle.

Percentage currency gain/loss versus US dollar from year-end 2015 to June 30, 2016 close:
Source: IFXA/Saxo Bank

Here's how the first half stacked up, month by month.

January: Traders were still nursing their hangovers when the Chinese stock markets dealt them a rude awakening. A 7% collapse in Chinese equity indices on January 3 triggered the brand new "circuit breakers" put in place to reduce the risk of such dramatic moves. Those circuit breakers ended up short circuiting a few days later and were scrapped.

The first Federal Open Market Committee meeting of 2016 caught markets offside with a dovish statement. As traders came to learn, it wouldn’t be the first time that “international developments” flipped caution lights on at the FOMC.

Most G10 currencies had reached their first-half 2016 peak or trough in the first 10 days of the month.

The month ended with the Bank of Japan introducing a tiered system of negative interest rates and delivering a dovish statement. To say FX markets were volatile would be an understatement.

February: The month opened with a nasty fallout from the Bank of Japan policy statement. USDJPY dropped to 110.98 from 121.45 by February 10, leading pundits to proclaim that the BoJ’s policy actions were a failure. Numerous commentaries cited the BoJ decision as evidence that the effectiveness of monetary stimulus packages may have run its course.

The dollar rallied against the majors. EURUSD roared to 1.1375 from 1.0890 by February 11. Comments from the People's Bank of China governor that there was no basis for further CNY devaluation or that China planned to tighten capital controls fuelled risk-on sentiment.

That sentiment accelerated when WTI crude oil prices, which had been declining since the beginning of the year, found a bottom at $26.20/barrel. By February 11, oil prices jumped into the driver’s seat for FX markets with rumours of a Russia/Opec meeting to discuss price support mechanisms.

Brexit concerns were minor fears as the UK prime minister David Cameron appeared to making good progress with the European Union in renegotiating Britain’s membership. The main focus was on European Central Bank president Mario Draghi and the ECB's next policy meeting in March with rising expectations of new stimulus programmes.

March: The month started with traders digesting a Group of Twenty statement that said the G20 would use all available tools to stimulate economies. Some analysts believed there was a tacit agreement to devalue the US dollar, partly because EURUSD started to climb and the commodity bloc currencies also rallied.

It was a month of central bank surprises. The Reserve Bank of New Zealand cut rates and delivered a dovish statement.

The ECB's Draghi, the “can-do" central banker became the “do-nothing" central banker. He had previously raised market expectations for an aggressive stimulus package and then underdelivered. He may have been forgiven for that, but then he said the “ECB doesn’t need to cut rates further”. Oops. EURUSD soared and has been in an uptrend ever since.

Then it was US Federal Reserve chief Janet Yellen’s turn. She surprised many traders with a dovish statement and the US dollar got whacked.

April: The highly anticipated April 16-17, Opec/non-Opec meeting in Qatar provided grist for the rumour mill for the first couple of weeks, raising expectations of production caps or other price support policies. They never occurred. Oil prices dropped to $37.55/barrel from $42.34/b, but the decline was not sustained and prices have climbed steadily since then. 

The FOMC minutes kicked off a June rate-hike debate, and the BoJ sent USDJPY tumbling when it failed to deliver additional stimulus measures.

May: The US dollar found its mojo. EURUSD began a steady decline from its peak at the beginning of the month and didn’t bottom out until the month was nearly over. USDJPY rallied from 105.57 and touched 111.40 at month-end. The commodity currency bloc came under significant pressure.

The Reserve Bank of Australia cut rates by 0.25% on falling inflation fears which gave rise to speculation that the Reserve Bank of New Zealand would follow suit in June. (they didn’t) . Wildfires in Alberta decimated the Canadian oil patch and raised questions about the health of the Canadian economy. Fairly hawkish rhetoric from Fed speakers, even the doveish ones helped to encouraged US dollar buying.

June: The month began with an ugly US nonfarm payrolls report. Analysts scrambled to revise 2016 rate-hike forecasts. Yellen reminded markets that it was just one piece of data and not to put too much weight on it. Except, the FOMC members did, and cited that report and Brexit concerns as reasons for remaining sidelined. In normal times, a disappointing Fed statement, lowered interest-rate forecasts and downgraded economic outlook would be the major market disruption of the month. Not this time.

The ECB rate decision and press conference was a non-event. The RBNZ decision caused a minor kerfuffle as about 30% of market participants expected a rate cut. It didn’t happen.

The 800-pound gorilla in the room for all of June was the UK's June 23 referendum on EU membership. Numerous polls showed that voters were almost evenly split. The lead shifted constantly, GBPUSD traded erratically, and that volatility spread to the G10 currencies as voting day neared. Still, despite all the polls, the sentiment appeared to be that the “Stay” camp would prevail. Even the UK Independence Party leader Nigel Farage, an avid "Leave" side proponent, said as much when he conceded victory on voting night. Ooops.

The experts got it wrong. The UK voted to leave the EU. GBPUSD collapsed. Risk aversion spread like a virus. On June 27, it looked like chaos and risk-averse trading would become the norm. The UK government was in shambles. The prime minister resigned, the Labour shadow cabinet resigned, and FX traders were resigned to volatility. GBPUSD made a fresh 30-year low. The rating agencies added to the misery when they cut  UK credit ratings. 

And then, like the Grinch growing a heart, a spark of optimism took hold, and by the time trading closed in June, beaten down currencies, including sterling, had rebounded as had equities and oil prices. The world lived to see another day.

How did you like the first half of 2016?

Gorilla   The 800-pound gorilla in the room was the UK's June 23 referendum on membership 
of the European Union. Photo: iStock

H2 no place for complacency

Many of the issues and concerns that dominated the first half of the year are still lurking in the shadows. Brexit heralded a new era of UK/Eurozone volatility, and this divorce will rank up there with some of the nastier divorces ever recorded.

Who is running the UK? The exiting cabinet is a government in name only. They have made the television series “House of Cards” look boring. The opposition parties are busy opposing each other. What are the UK’s obligations to financial support of Greece? How does Brexit effect any number of prior commitments for financial support to the EU? Will the UK’s dissatisfaction with the EU have a contagion effect on other EU members? And those concerns are mere drops in the sea of what is in store in the coming months.

What about the US? The Fed can’t figure out what message it is trying to deliver to markets. The US presidential elections will be a major distraction.  Republican candidate Donald Trump wants to pick a fight with China over trade and currency levels, build a wall between the US and Mexico and oust Yellen.

The OECD, IMF and various central banks have downgraded their economic growth forecasts for the second half. That doesn’t bode well for additional commodity price gains and may impact the prospects for additional US growth. Some analysts are predicting that the US is in danger of recession.

Geopolitical tensions are just below the surface. Nato, led by the US, is actively antagonising Russia by holding training exercises close to Russian territory. Britain, Germany and the US are planning to deploy 4,000 troops to Poland and the Baltics. Even Canada is getting into the act by sending a battalion to Latvia.

North Korea is still test-firing missiles in an effort to build a long-range nuclear capability. China continues to expand its territorial claims in the South China Sea. There have been more than a few military “incidents” between China, the US and other nations attempting to dissuade China from its actions.

And those are just a few of the issues that may affect FX markets in the second half of 2016. This year has been a traders' market so far, and there is no reason to expect anything different in the months ahead.

Plan your trades and trade your plans.

Do you have a plan?

Get a plan for H2. Photo: iStock

— Edited by John Acher

Michael O'Neill is an FX consultant at IFXA Ltd.
01 July
John Shaw John  Shaw
Fantastic piece today Mike. Thanks for sharing. Have a great holiday.
01 July
Michael O'Neill Michael O'Neill
Thanks John-and you get the extra day on Monday because of your US branch. Lucky you


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