For completely different reasons, 2016 certainly hasn’t been kind to the US dollar and British pound. The US dollar is trading negatively against a basket of currencies for the year, while the pound has undergone a period of volatility unseen in its recent history. Below we look at where these two currencies could end up by the end of 2016.
The US dollar index, a measure of the greenback against a basket of six currencies that includes the euro, Japanese yen, British pound, Swiss franc, Canadian dollar and Swedish krona, has declined nearly 3% since the start of the year. There are many reasons why this is the case, but the primary reason concerns Federal Reserve and expectations about monetary policy.
At the end of last year, when the Fed decided to raise interest rates for the first time in nearly a decade, policymakers forecast four rate hikes in 2016.[1] By June, the Fed had not yet raised interest rates. Rather than four rate increases, policymakers were now forecasting only two. But even two rate hikes in 2016 are considered to be highly unlikely. As rate-hike bets have waned, so too has the performance of the US dollar.
So why has the Fed failed to raise interest rates? For starters, the US economy underperformed in the first half of 2016. An increasingly volatile international climate marked by an equities selloff at the start of the year and Britain’s decision to quit the European Union in June kept policymakers on the sidelines. At this rate, it’s pretty much a coin toss whether the Fed raises rates in 2016. If they do, then based on what happened at the last increase in December 2015, the US dollar may strengthen across the board.
Britain’s shocking decision to leave the EU triggered an unprecedented selloff in the pound, with the GBP/USD plunging at a double-digit percentage pace to 31-year lows. Since the historic vote, the pound’s outlook hasn’t really improved. In fact, it may have gotten worse since the Bank of England (BOE) voted to ease monetary policy for the first time since 2009. The Bank also expanded its quantitative easing program and made the biggest quarterly downgrade to GDP growth in decades.[2] Obviously, the BOE’s Monetary Policy Committee isn’t taking any chances on Brexit.
Since the Bank is expected to ease monetary policy further in the foreseeable future, it’s difficult to imagine a scenario whereby the British pound improves from its current levels. At its lowest, the GBP/USD briefly fell below 1.30. It is currently trading the low-1.33 region.
The pound’s performance over the past month or so suggests that it has already bottomed. Barring a Federal Reserve rate hike, the GBP/USD should continue consolidating in the mid-to-upper 1.30 region by the end of the year.[3]
[1] Christopher Condon (January 6, 2016). “Fed’s Fischer Says Four Rate Hikes in 2016 ‘in the Ballpark’.” Bloomberg.
[2] Catherine Boyle (August 4, 2016). “Bank of England cuts key rate for the first time in over seven years to 0.25%.” CNBC.
[3] Joaquin Monfort (August 16, 2016). “Pound to Dollar Rate Forecast to Hit 1.28 and then Recover (If this Double-Bottom Proves True). Pound Sterling Live.
