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Trends to watch 2016

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Trends to Watch 2016 © 2016 NetoTrade. All rights reserved.
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Trends to Watch2016

© 2016 NetoTrade. All rights reserved.

Contents

Chinese Devaluation Endures

Chinese Yuan Set to Weaken Further Amid Trade DownturnUpside pressure on the Yuan and a peg to the US dollar has given way to an official revaluation lower as policymakers attempt to keep the currency competitive amid a strengthening US dollar.

• 2015 saw imports slide precariously, denting commodity prices• Producer prices have edged lower into deflationary territory for nearly 4-years• 6 rate cuts in 2015 are likely to be matched by additional action in 2016• Ripple effect from China likely to impact both emerging and developed markets

globally thanks to greater worldwide economic integration.

Central Bank Intervention • The People’s Bank of China has responded to worsening economic conditions with a

number of monetary policy adjustments over the last year and direct intervention in financial markets, namely equities

• 6 cuts to the benchmark interest rate were flanked by 4 reductions in the reserve ratio requirement for local Chinese banks, helping to flood the market with additional liquidity and make borrowing conditions more attractive

• Following a period of strengthening beginning in 2010 the Yuan reached its heights

against the US dollar in early 2014 before reversing course.

Worsening Liquidity Conditions• Capital outflows reached approximately $750 billion in 2015 according to estimates,

setting the stage for an acceleration in pace in 2016 as the economy worsens and the

Yuan is devalued additionally.

Devaluation\(ˌ)dē-ˌval-yə-ˈwā-shən, -yü-ˈā-\

A reduction in the value of an asset or official lowering of an exchange rate with the value of local currency lowered against another currency or asset.

US Equity Bull Market Struggling to SustainAfter rebounding from 2009 lows, US stocks are in for a rocky year ahead as the accommodative measures that supported gains are gradually removed by the Central Bank

• Zero interest rates changed traditional risk-reward conditions• Central Bank balance sheet expansion and liquidity provision enhanced

bull market by redirecting investment flows• Valuations overextended due to lacking investment opportunity

elsewhere

Current Valuations Rich• The current S&P 500 price-to-earnings multiple well exceeds the longer-

term average, a sign that stocks are overextended to the upside and due for a sharp correction

US Bull Market Concludes

Bear Market \ˈber\ \ˈmär-kət\• A market in which prices of an asset are generally trending lower, inciting selling• Classically defined as a 20% drop in an asset’s price from highs

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Trends to Watch 2016 3

Trends to Watch 2016 4

No more buying the dips in 2016, the time has come to sell the rallies

As benchmarks including the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite approach bear market territory, the key to successful strategy is not chasing after downside momentum

The better strategy for trading US equity indices is selling any pullback and rally to the upside using a swing trading strategy

Useful indicators such as the RSI and moving averages should be employed to help determine entry points

The Strategy

US Bull Market Concludes

Chinese Devaluation Endures

Chinese Devaluation Endures

Chinese Yuan Set to Weaken Further Amid Trade Downturn

Upside pressure on the Yuan and a peg to the US dollar has given way to an official revaluation lower as policymakers attempt to keep the currency competitive amid a strengthening US dollar.

• 2015 saw imports slide precariously, denting commodity prices• Producer prices have edged lower into deflationary territory for nearly

4-years• 6 rate cuts in 2015 are likely to be matched by additional action in 2016• Ripple effect from China likely to impact both emerging and developed

markets globally thanks to greater worldwide economic integration

Central Bank Intervention

The People’s Bank of China has responded to worsening economic conditions with a number of monetary policy adjustments over the last year and direct intervention in financial markets, namely equities Following a period of strengthening beginning in 2010 the Yuan reached its heights against the US dollar in early 2014 before reversing course

Worsening Liquidity Conditions• Capital outflows reached approximately $750 billion in 2015 according

to estimates, setting the stage for an acceleration in pace in 2016 as the

economy worsens and the Yuan is devalued additionally

Devaluation\(ˌ)dē-ˌval-yə-ˈwā-shən, -yü-ˈā-\

A reduction in the value of an asset or official lowering of an exchange rate with the value of local currency lowered against another currency or asset.

Trends to Watch 2016 5

The Strategy

Chinese Devaluation Endures

Trends to Watch 2016 6

Capital flight remains a real risk in 2016, with policymakers working to prevent outflows by implementing capital controls

Dips in USDCNH should be used an opportunity to get long, while chasing after a rally is unwise considering the currency does not free float and is susceptible to Central Bank intervention

Commodity Currency Carnage Far From Over

Currencies of leading commodity producing nations poised to fall further as economic activity globally decelerates, leading to less demand and chronic oversupply in key staples including energy, mining, and agriculture

• Weaker metals demand from China and oversupply sinking Australian Dollar

• No end in sight global trade slowdown, denting outlook for a price rebound

Weak Base Metals Demand Harms Australian Mining

• Plagued by overcapacity and waning demand, miners have moved to cut capital expenditures, investment projects, and shuttered costlier projects in order to weather the storm still brewing in prices

• Mining and minerals will continue to drag on Australian dollar until prices

rebound and supply glut eases

Natural Resource \ˈna-chə-rəl, ˈnach-rəl\ \ˈrē-ˌsors, -ˌzors, ri-ˈ\

Materials, minerals, or animals found in nature that are assigned value.

Commodity Currencies Pinched

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Trends to Watch 2016 7

Trends to Watch 2016 8

Commodity Currencies Pinched

The Strategy

Falling prices will require additional accommodation from the Central Banks of countries dependent on commodity production as they try and offset the losses in the sector by promoting easy borrowing and consumption in other areas such as services

Commodity currencies remain a strong secondary play for any directional momentum movements in the underlying commodity

Dollar Rally to Persist on Hawkish Rate Outlook

The United States dollar outlook is strong thanks to the ongoing divergence in monetary policy in comparison to other advanced economies with the Federal Reserve currently on track to gradually liftoff a buildup of small consecutive rate hikes in 2016

• Labor market performance robust enough to shoulder rate hike impact• Inflation a headwind to Central Bank’s ambitious tightening plans• Change in investor sentiment from yield to quality to benefit dollar flows• Other advanced economies likely to ease policy further amid slow growth

Labor Results Supportive of Higher Rates

• The US unemployment rate at 5.00% has matched the Federal Reserve’s jobs mandate to target maximum employment within the economy

• A recovery in labor force participation to serve as further confirmation that the labor economy is improving and able to withstand the impact of higher interest

Inflation Remains Unanchored

Although inflation is unlikely to experience some of the same pressures as 2015, until the figure recovers further, rate hikes will be pushed towards the end of quarters in an effort to judge economic performance subsequent to policy changes

Monetary Accommodation Prevails in the Developed World

Most of the G7 economies forecast to leave rates on hold or accommodate policy further to isolate external conditions from domestic economies, fueling further losses in local currencies versus the US dollar

The US Federal Reserve being the first Central Bank to tighten sets the tone for the US dollar as investors clamor for more USD-denominated assets

Monetary Policy \ˈmä-nə-ˌter-ē also ˈmə-\ \ˈpä-lə-sē\

• The set of tools employed by a Central Bank to influence the money supply and interest rates• Dollar Rally to Persist on Hawkish Rate Outlook

Dollar Rises on Policy Tightening

Trends to Watch 2016 9

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The Strategy

Dollar Rises on Policy Tightening

The US dollar is expected to rally further over the coming year, benefiting from investment flows looking for more consistent and stable returns

Global headwinds and a weak economic backdrop in most developed and emerging economies will weigh further on local currencies

The US dollar will hurt exports, but this is not critical considering the ample benefits that policy normalization will bring to the economy

Dollar dips should be bought against all currencies

Developing Economies Feeling the Brunt of the Global Trade Downturn

Tidal wave of investment flow out of emerging markets as weakening trade conditions and falling commodity prices dampen the outlook for a recovery in the local currencies

• Risks for export oriented emerging economies surge as declines in local currency erode purchasing power and also heighten inflationary risks

• Investment dollars chasing after quality assets instead of high yielding instruments as global outlook darkens

• Velocity of global trade decelerating and tanker rates hitting new lows may signal a pause in global growth and potential recession

• Rampant commodity deflation indicative of weak end-demand in a sign of more turbulent times to come for trade-dependent economies

Devaluation Raises Risks

• The devaluation of a local currency does broadly benefit output by making exports more competitive, but it also raises the price of imports and leads to declining purchasing power over time

• Loss of purchasing power leads to more individuals converting local currencies to more stable foreign currencies in an effort to preserve wealth and protect against the erosion of purchasing power

Emerging Market Crisis Spreads

Emerging Market \i-ˈmərj-ing\ \ˈmär-kət\

An economy that is undergoing development and reform and typically defined by low to medium income levels on a per capita basis

Trends to Watch 2016 11

Flight to Quality

• Over the years of zero interest rate policies, investment capital especially from the US flowed to many emerging markets in an effort to capitalize on higher yielding assets in response to low returns in advanced economies

• The gradual improvement in advanced economies and prospect of continued monetary policy tightening has seen the funds formerly chasing after returns in emerging economies reverse course and head back towards advanced economies, with investors favoring quality

• Continued risk off behavior is likely to drive emerging market currencies even lower over time as risks to the outlook remain firmly biased to the downside

Softening Trade Raises Risks

• International trade conditions continue to worsen as evidenced by weak shipping rates and reduced commodity demand, demonstrated by plummeting commodity prices and spare capacity in key industries

Emerging Market Crisis Spreads

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Trends to Watch 2016 12

Trends to Watch 2016 13

The Strategy

Emerging Market Crisis Spreads

Emerging market currencies such as the Russian Ruble (RUB), Turkish Lira (TRY), and South African Rand (ZAR) should be sold against foreign exchange major such as the US dollar, Euro, Pound, and Franc

Falling commodity prices, especially metals, should be used as a guide for trading the currencies using falling oil and gas prices to foreshadow additional losses in the Ruble, slipping gold prices to predict changes in the Rand (ZAR), and additional political conflict to exacerbate weakness in the Lira (TRY)

Divergent Policies to Drive Deeper Downside in EURUSD

The deviation in economic outlooks has driven a wedge between monetary policy in the United States and the Euro Area with the former continuing to experience more robust growth while the latter is still weighed down by continued emphasis on austerity versus fiscal stimulus

• Federal Reserve poised to raise interest rates further in 2016 as economic tailwinds boost the outlook for the economy

• European Central Bank forecast to leave deposit rate in negative territory and continue asset purchases to stimulate investment and lending

US Federal Reserve to Tighten Further • Even though positive conditions tapered towards the end of the 2015, gains in unemployment

and a more anchored outlook for inflation in 2016 paved the way for liftoff back in December and additional policy adjustments in 2016

• Additional rate hikes are expected in 2016 • Further tightening of monetary policy measures likely to drive the US dollar higher versus

peers as investors shift to the relative quality of US assets• The rising dollar will dent the export economy and manufacturing, but give the Federal

Reserve additional tools to fight any future crisis•

Absence of Fiscal Stimulus Complicates Outlook• The lack of uniform fiscal policy and heavy indebtedness of European countries is forcing

sovereign nations to focus on cost cutting • Fiscal stimulus is also absent in the United States with the Federal Reserve acting as the main

source of policy accommodation as the fiscal situation in states deteriorates further over time• Lacking uniformity in measures and sovereign decision-making in Europe is preventing a

unified front towards fiscal stimulus whereas the US Government can implement an all-encompassing plan that would benefit the entire country in a much simpler fashion

Parity \ˈper-ə-tē, ˈpa-rə-\

• The state of equivalence between two assets and their respective equal prices

Euro-Dollar Parity Plunge

Trends to Watch 2016 14

Trends to Watch 2016 15

The Strategy

Euro-Dollar Parity Plunge

Euro Area monetary policies are likely to keep the pressure on the Euro while by comparison, parallel US policies are expected to contribute to further upside in the US dollar over time

With the tailwinds for the US dollar and emphasis on accommodation in Europe, the EURUSD currency pair is expected to retreat over time


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