Foreign Exchange outlook

A notable increase in FX volatility has occurred in recent weeks, particularly among the major currencies. Sudden sharp movements affected the Japanese yen and the UK pound, albeit in opposite directions. In addition, most of the gains in the euro in the first half of February – linked to safe haven demand – have since been reversed. In contrast, the Chinese renminbi has recovered its composure following a tumultuous start to 2016, as Beijing raided its reserves in support. The recalibration of US rate expectations, which has led to a recovery in oversold emerging currencies, indicate that FX volatility may be somewhat lower in the weeks ahead. Relative fundamentals suggest a positive outlook for the US dollar, which should resume an uptrend. Yet, rather than driven by internal economic strength, its climb may become more a function of external weakness and risk events. More cautious statements from the US Fed have led markets to price in a flatter yield curve for 2016, but the rate differential with respect to other major countries should remain in its favour.

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