Currency: Diverging Inflation and Monetary Policy

Global growth concerns, expectations of diverging monetary policy and higher volatility have revitalized the currency market-a trend we see continuing in the year ahead.

Anticipation of a rate increase by the Fed propelled the U.S. dollar higher in 2014 and, to a lesser extent, in 2015. Signs of softer economic data, weak inflation and global unrest later caused the Fed to delay "liftoff" until December. This resulted in a more range-bound trading environment in which consensus trades were slowly unwound.

Looking to 2016, we believe inflation and monetary policy should remain key drivers of the currency market. With few exceptions, economic growth has moderated and inflation is generally tepid around the world. As a result, many central banks have continued to pursue accommodative monetary policies. While slack in the U.S. economy remains, in our view, its recovery is sustainable and inflation will move modestly higher over the next year. Thus, we believe the Fed is likely to gradually raise rates in 2016, which should lend support to the U.S. dollar on the margin.

In contrast, lack of inflation in Europe and Japan has forced the ECB and Bank of Japan to maintain an accommodative stance, despite a gradual pick-up in economic activity. Despite loose monetary policy and unfavorable yield differentials, we expect the euro and yen to be range-bound as the macroeconomic picture should gradually improve in both regions.

Elsewhere, we have a negative view on the Swiss franc. In 2015, it was generally viewed as a safe haven given the turmoil in Greece. With this now less of a concern, the Swiss franc could depreciate in the coming year. Regarding the commodity currencies, the Australian and New Zealand dollars have been dragged down by falling energy prices and weak demand in emerging markets. While we have a less negative longer-term outlook for both currencies, we remain cautious for the time being.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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