3 Major Themes that Drove the Forex Market in Q1 2016

Q1 2016 is coming to an end, so let’s take sit back, relax, and take a look at some of the major themes that had a broad effect on price action in the forex market.

1. Chinese Stock Market Meltdown

China started the new year with a stock market meltdown that triggered the so-called “circuit breaker” on January 4 and then on January 7, with the January 7 session being halted after just 15 frigging minutes of trading and then suspended for the rest of the day a few minutes later.

For the forex traders out there who don’t know (or just forgot), this so-called “circuit-breaker” was a system meant to keep the Chinese equities market stable by preventing panic selling. There are a lot of rules, but the most basic is that trading is suspended for about 15 minutes or so if an equity index falls by 5%, but if an index falls by 7%, then trading is halted for an entire day.

Getting back on topic, there was no clear catalyst for the meltdown, but I noted in an earlier write-up that the downbeat Caixin manufacturing PMI at the time (48.2 vs. 48.9 expected, 48.6 previous) was likely one of the main catalyst, at least for the January 4 slump. Chinese officials went into damage-control mode on January 8 by raising the peg on the Chinese yuan for the first time in 9 days and suspending the circuit-breaker.

However, the damage was already done and the Shanghai Composite Index closed the week 9.97% lower. China’s meltdown wasn’t isolated, though, since it also dragged global equities lower across the board. The pan-European FTSEurofirst 300, for example, was down by 6.74%, which is the biggest weekly loss since August 2011. U.S. equity indices, meanwhile, had the worst ever 5-day start to a year in history, with the DOW slumping by 6.19% for the week and the S&P 500 down by 5.96% for the week.

That’s great and all, but how did that affect the forex market, you ask? Well, as Pip Diddy reported in his Top Forex Market Movers of the Week (Jan. 4-8, 2016), the intense risk aversion caused forex traders to flee en masse to the safe-haven currencies, particularly the Japanese yen while avoiding the higher-yielding one, namely the comdolls. And concerns over the Chinese economy caused Chinese equities to continue slumping until the following week, dragging global equities lower for yet another week, which naturally caused even more terrified forex traders to scurry to the Japanese yen.

2. Oil’s Roller Coaster Ride

Jitters over the Chinese stock market meltdown, the lifting of sanctions on Iran, and oversupply concerns kept oil mostly on the defensive during the first half of the quarter. However, things finally began to look bright and sunny in mid-February (that kinda rhymes) when OPEC and non-OPEC oil producers, especially Russia and Saudi Arabia, sat down to reason together and agreed to freeze oil output at January levels.

Iran didn’t wanna be part of the deal, though, because the sanctions against it have just been recently lifted. But heavy speculation that Iran can be reeled into the deal during the upcoming April 17 meeting (was originally set for mid-March) has been pushing oil benchmarks ever higher.

And as I noted in yesterday’s 6 Biggest Forex Moves You Could’ve Caught in Q1 2016, USD/CAD was one of the most delicious plays during Q1 2016, and the oil rally was one of the major drivers for that. If you don’t know what oil has to with the Loonie, then that’s probably because you missed our School’s lesson on How Oil Affects USD/CAD.

Anyhow, the Loonie wasn’t the only one that got pushed around by oil’s price action because it just so happens that oil began to lead (or at least had a very strong correlation with) price action in the global equities market as well, as I highlighted in my Quick Primer and Some Updates on Crude Oil. And as I said in that write-up, even big shots like former Fed Head Ben Bernanke began commenting on it.

And since global equity indices are excellent for gauging overall market sentiment, demand (or lack thereof) for safe-haven currencies and higher-yielding ones shifted depending on how oil performed.

3. Central Bank Actions and Biases

Oil’s weak start and jitters over China’s economy had a direct impact on forex price action by influencing risk sentiment, but they also had a less direct impact via central bank actions and biases.

One of the most noticeable was the U.S. Fed’s switch to a more dovish tone during the January FOMC Statement, which later evolved (or devolved more like) into downgrades for inflation and growth forecasts, as well as a slower path to tightening during the March FOMC statement.

China’s slowdown and previous drops in oil prices are also the reasons why the RBNZ had a preemptive surprise rate cut in March and the BOJ introduced negative rates back in January, although forex traders ultimately ignored that and focused on yen’s status as a safe-haven instead, as I mentioned in yesterday’s write-up.