The beginning of 2016 has been a rude awakening for equity bulls, and those invested in high yielding asset classes traditionally associated with “risk-on” sentiment. While it is still too early to conclusively state the macroeconomic themes shaping the investment climate over the balance of 2016 are set in stone, there is evidence to suggest investor expectations are in a state of flux, and this uncertainty around ongoing policy action from key central banks is opening the door for financial markets to experience longer periods of heightened two-way volatility. Today’s price action has yet to kick the pessimistic sentiment hanging like a dark cloud over financial markets, with Chinese equities being halted in early trading after the Shanghai Composite crashed by 7%. The rout in the S&P looks set to pick up where trading left off yesterday, with futures pointing to another sharply lower open, heading back into the low 1900s. Front-month WTI has wandered into somewhat of a proverbial perfect storm to start the year, with the political strife between Iran and Saudi Arabia making it seemingly impossible those two parties within OPEC will be able to agree on cutting production in the near future, along with the fact that the shaky ground of the Chinese economy isn’t doing anything to ease investor concerns the demand side of the equation will pick up anytime soon. Tumbling oil prices have in turn fanned speculation that the slack in the Canadian economy could persist for a greater amount of time than the Bank of Canada is currently forecasting, and that the central bank may have to ease lending rates further in order to buffer a sharper downturn across the nation as business investment continues to head for the exits. Subsequently, the Canadian dollar is off over 2% against its American counterpart to start the year, with momentum on the side of loonie bears. The sour risk appetite that has permeated through global financial markets to start the New Year is by in large attributable to shifting tectonic plates in China, with the People’s Bank of China aggressively fixing the CNY lower against the USD, shaking investor confidence and leading to halts in local stock exchanges as selling pressure trips circuit breakers. While the idea that Chinese leadership would need to undertake greater policy prescriptions in order to combat a slowing economy has been well discussed here, the weakening of the CNY as a lever to steer monetary policy in itself is not what is likely spooking investors; however, it is uncertainty around future policy, and what the application of this looks like. The leading economic indicators are continuing to suggest the downturn for the Chinese economy has not yet run its course, and this will likely spur further accommodative monetary policy conditions from the central bank. The challenge will be that even though we will see pockets of strength in the commodity complex as stimulus injections provide support, concerns that global demand will remain soft as China struggles to stickhandle around finding a sustainable growth trajectory that doesn’t choke off domestic consumption will weigh on market participants’ confidence. In addition to question marks around how pronounced the slowdown in China really is, financial market participants will also have to contend with deciphering a lift-off schedule for interest rates in the United States that may alter substantial from what markets are currently anticipating. At the Fed’s last policy meeting in December, the updated dot plots from the FOMC illustrated the board had neatly penciled in four rate hikes over the course of 2016, with the caveat the incoming data must corroborate a healthy economic landscape before additional increases were warranted. The minutes released yesterday outline a committee that seemed slightly more cautious than market participants originally assumed from the rate hike and accompanying statement back in December, with the effects of lingering low inflation making the interest rate hike a “close call” for some members. We would also expect the volatility in financial markets since the last rate decision will influence the outlook on the trajectory of interest rate for committee members, especially if the downturn in equities continues and there is increased pressure on commodities. While the downward pressure on inflation has been looked at by many on the FOMC as transitory in nature due to lower oil prices, persistently low readings and a lofty American buck could start fraying expectations additional hikes will occur at roughly every other meeting over the course of the year. Therefore, there is the potential to see the pendulum on Fed interest rate policy take a dovish swing like the middle of 2015, and will be something market participants will have to be aware of as incoming data hits the wires. The dueling effects of a strong ADP employment report and slightly cautious FOMC minutes have left the big dollar mixed so far this week, but participants should buckle up as the conclusion of the week approaches and the Non-Farm payrolls report dominates price action. Further reading: Elliott Wave Analysis on GOLD and AUDJPY GBP/USD dips to lowest since 2010 – false break? Scott Smith Scott Smith Scott Smith is a Senior Corporate Foreign Exchange Trader with Cambridge Mercantile Group and has a diverse background in the foreign exchange industry, with previous experience in both credit and trading related functions. Scott holds a Bachelor of Commerce degree from the University of Victoria, has completed all three levels of the Chartered Financial Analyst designation, and is currently working towards the Derivative Market Specialist certification offered through the Canadian Securities Institute. Cambridge Mercantile Group. View All Post By Scott Smith Forex News Today: Daily Trading News share Read Next AUD/USD settles under 0.70 – levels to watch Yohay Elam 6 years The beginning of 2016 has been a rude awakening for equity bulls, and those invested in high yielding asset classes traditionally associated with "risk-on" sentiment. While it is still too early to conclusively state the macroeconomic themes shaping the investment climate over the balance of 2016 are set in stone, there is evidence to suggest investor expectations are in a state of flux, and this uncertainty around ongoing policy action from key central banks is opening the door for financial markets to experience longer periods of heightened two-way volatility. 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