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Trading Opportunities of 2016: Risk-off in the Front, Policy in the Back

Trading Opportunities of 2016: Risk-off in the Front, Policy in the Back

The Federal Reserve is widely expected to begin tightening monetary policy with its first post-QE interest rate hike at the December 2015 FOMC meeting. This ought to set the stage for a two-part macro fundamental narrative in 2016.

The first act seems likely to be characterized by risk aversion. The Fed’s aggressive easing effort over the past seven years slashed returns on safer assets and encouraged a reach for yield outward along the risk spectrum (see chart). As short-term borrowing costs begin to rise, this dynamic is likely to begin reversing, driving portfolio adjustment that ought to see sentiment-linked currencies like the Australian Dollar head lower alongside stock prices.

Source: IEconomics

Following the realignment of market-wide risk/reward parameters, the second act is likely to see monetary policy divergence return to focus. With that Fed lining up as the only central bank firmly on the hawkish end of the scale, this will probably bode well for the US Dollar. The British Pound seems likely to benefit as well as the Bank of England angles to be the first to follow the US central bank down the path to normalization.

The Euro seems most vulnerable as the ECB ramps up stimulus efforts to beat back deflation fears. The single currency may find support through risk aversion in act one as carry trade liquidation bolsters the newly-minted funding currency. This might make for attractive selling opportunities in the second part our narrative when relative policy considerations return to the forefront. Australian Dollar weakness may continue as well. A structural slowdown in China bodes ill for economies dependent on demand from the East Asian giant and seems likely to keep the RBA on hold at best, driving a widening wedge between it and hawkish central banks (notably, the Fed).

See the next Top Trade Opportunities in 2016: AUDJPY | Carry Interest Vulnerable to Fed Hikes

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.