Currencies have become the “tail that wags the dog,” in terms of the increasingly disruptive impact they have had on the global economy since 2015. Two key developments in 2015 stand out in this regard—the dollar's relentless advance against every major currency, and in particular its surge against currencies of commodity exporters; and the yuan's shock devaluation over the summer that led to a short and sharp correction in global equities (see "The Chinese Devaluation of the Yuan"). With global markets having their worst start in years after China again devalued the yuan in the first week of January, expect currency turmoil to continue in 2016, with the spotlight on these four currencies. (For more, see: The Effects of Currency Fluctuations on the Economy.)
Chinese Yuan
The dollar may be reigning supreme in forex markets, but in recent months it's the Chinese yuan that's been the focus of global angst. The yuan is not a floating currency whose exchange rate is determined by market forces; rather, China's central bank—the People's Bank of China (PBOC)—uses a "managed float" system to determine its rate against a basket of managed currencies including the U.S. dollar. China had been allowing the yuan to appreciate gradually for a 10-year period that ended in 2014, partly in response to strident calls from U.S. lawmakers for yuan revaluation in order to curb the nation's soaring trade deficit with China. However, since reaching its strongest ever level of just above six to the dollar in January 2014, the yuan has been allowed to creep lower as the dollar runs rampant. (For more, see: Why China's Currency Tangos With the USD.)
So why were markets so rattled by the yuan's record 1.8% devaluation on August 11, 2015, and an eight-day depreciation of 1.4% in the first week of January 2016 (including a 0.5% devaluation on January 7) that took the currency to its lowest in almost five years? For a number of reasons. Firstly, the willingness of China to let the yuan trade lower indicates that the economy may be even weaker than the official figures suggest. Secondly, a lower yuan would result in cheaper exports from China and intensify deflationary forces in the global economy. And finally, it may spur a cycle of competitive devaluations as nations depress their currencies to compete with the yuan. All these factors have negative implications for the global economy and its growth prospects. Overall, expect the yuan, which currently trades at 6.56 to the dollar, to continue occupying center-stage in 2016. (For related reading, see: What Is A Currency War And How Does It Work.)
Canadian Dollar
The Canadian dollar—or "loonie" as it is known in the forex world—plummeted 16% versus the greenback in 2015, the third-worst performance of 16 major currencies, capping a three-year slide of a record 28%. The currency's plunge in 2015 was precipitated by the perfect storm of bearish factors: a recession in Canada in the first half of the year, slowing global growth, two interest rate cuts by the Bank of Canada, lower commodity prices, and finally, a 30% plunge in crude oil prices.
The drag exerted by these factors on the currency could ease up in 2016. The Canadian economy is expected to benefit from the tailwinds of monetary and fiscal stimulus and a weak currency, while pockets of strength in some parts of the world (like the U.S., Canada's largest trading partner; and India) and a modest recovery in others (Europe, Japan) could offset the slowdown in China. Non-energy exports are also picking up. In November, exports rose 0.4% to C$43.3 billion after declines in the three preceding months, led by a 5.9% increase to C$7.9 billion in sales of motor vehicles and parts; automobile shipments have surged 24% over the past year.
Odds of a rate cut by the Bank of Canada in 2016 to a record low of 0.25% are rising, which may pressure the loonie if the Canadian and global economies weaken. Currency traders, however, are optimistic about the chances for a recovery in the Canadian dollar in 2016. The average forecast in a Bloomberg survey for the end-2016 C$ spot rate is 1.33 (or just over 75 U.S. cents), compared with the present exchange rate of 1.4050 (about 71 U.S. cents).
Euro
The euro came under speculative attack in the first half of 2015 as a political crisis in Greece once again stirred concerns about the future of the euro area. The currency conceded the global stage to the yuan after the latter's unexpected devaluation in August, and ended 2015 down 10.2% vs. the dollar. In December, it had tumbled to around 1.05 to the U.S. dollar, on expectations for expanded monetary stimulus measures from European Central Bank President Mario Draghi, but rebounded after Draghi's measures were less dramatic than expected. While some currency traders think the euro could fall to parity with the greenback in 2016, Bloomberg survey participants forecast only a modest weakening in the currency this year, to 1.06 from its present level of 1.08.
Brazilian Real
The Brazilian real was the worst-performing major currency in 2015, plunging 33% against the U.S. dollar, and bringing its decline versus the greenback since 2010 to a staggering 58%. The currency reached a record low of 4.25 against the U.S. dollar in September after Standard & Poor's cut Brazil's credit rating to junk amid a deep recession, political stalemate and a widening corruption probe into state-owned oil company Petrobras. With business and consumer confidence continuing to plummet, and Brazil's equity index near a seven-year low amid a global sell-off in the first week of January, the real may be hard-pressed to recover in 2016. In fact, the currency could trade at new lows if commodity and energy prices continue to tumble in 2016.
The Bottom Line
These four currencies will be under the spotlight in 2016, with the Chinese yuan in particular at center stage.
