Fed on hold
The Federal Open Market Committee (FOMC) conclude their policy meeting today and it is expected that this will be the fifth consecutive meeting where monetary policy is left on hold following last December’s rate hike. Market expectations about the FOMC’s intentions have been volatile through the course of this year as the FOMC’s ‘policy guidance’ itself has been volatile, often depending on what is happening in financial markets rather than necessarily in terms of its economic mandate. Being asset price dependent rather than data dependent creates the risk of a feedback loop in which the markets believe the FOMC becomes more hawkish when equity markets are moving higher and becoming dovish when equity markets are moving lower. This is a recipe for an increase in financial instability.
Hence, at the start of this year, the FOMC’s own interest rate projections (the so-called ‘dots’ looked for four quarter-point rate hikes this year. This was quickly revised to just two in reaction to the market slide earlier in the year and escalation in international economic and financial uncertainty (China FX policy, an elevated US dollar and a weak oil price). Although, the Chinese currency has depreciated both against the US dollar and in terms of the currency basket, the proposed inclusion of the RMB into the SDR in October implies that devaluation risks for the financial markets will be limited. The US dollar is fairly flat but the oil price is weakening again though much of the oil industry’s adjustment of investment plans has probably already taken place.
Now the markets are pricing in just one rate hike this year with ‘Fed-watchers’ looking at the 21 September and 14 December FOMC meetings as being the timing of the next move. A rate hike at the 2 November FOMC meeting is unlikely given the proximity to the US Presidential election. Janet Yellen’s next public pronouncement will be at the Kansas City Fed’s annual economic symposium on 26 August where the programme this year will be on the design of monetary policy frameworks (see previous years’ programmes here). Brexit uncertainties seem to be dissipating and the consensus view that Brexit would cause a long-standing economic and financial shock seems to have been mistaken.
The FOMC has never tightened monetary policy in the month preceding a Presidential Election though: since 1964 the FOMC has raised interest rates eight times in the year of the election. The path of US bond yields during an election year does not depart much from the average pattern which indicates a seasonal bias to rise in early February before drifting higher through mid-May and slowly decreasing into the year-end. This is more or less what has happened so far with the US 10-year Treasury yield this year. As an aside, the upward pressure on libor interest rates reflects a recent increase in the demand for US dollars as a result of funding pressures, especially with Eurozone banks and also the impact of regulatory changes for US prime money market funds that come into effect on 14 October.
Equity markets have enjoyed a strong rally on the basis that the major central banks remain accommodative and this reflationary theme is bolstered by the re-iteration of using fiscal policy as a demand-management tool at the G20 meeting at the weekend. The S&P500 index is at a new high though valuations are historically very stretched. The US economic data surprise index has been rising (i.e. the data has tended to be better than expected, though yesterday’s US PMI service index at a five-month low pointed to sluggish growth).
Separately, Japan is expected to implement a fiscal stimulus soon with about JPY 6tn in new funding and the BoJ might announce fresh monetary measures at its policy meeting later this week. The Japanese two-year bond yield fell to a record low of minus 0.37% and the USDJPY exchange rate moved back towards the 106 level. The exception to the advance in EM equity markets, which are at an 11-month high, is China where the regulator is said to be considering tightening curbs on the USD 3.6tn market for wealth management products.
As far as equity markets are concerned, the main threat to sustaining the rally is upcoming political risk in the form of the Italian constitutional referendum scheduled to be held in October. The popularity of the anti-euro Five Star Movement has fanned ‘Quitaly’ concerns. The under-capitalisation of the Italian banking system will be revealed in the publication of the banks ‘stress tests’ this Friday. In time-honoured fashion, there will likely be a ‘last-minute’ deal to allow some state recapitalisation of the Italian banking system that mitigates the cost to bank bondholders of being ‘bailed-in’ (see Italy’s bail-in headache by Silvia Merler of Breugel). The next key political risk is the US Presidential election in November. Recent opinion polls have given Donald Trump a slight lead over Hillary Clinton. The financial markets’ preferred candidate for the White House is Hillary Clinton as she represents the status quo and is seen as friendly towards Wall Street. A Trump Presidency, on the other hand, would augur a change in economic policy that is a lot more protectionist (‘America First’). Janet Yellen would probably lose her job though Donald Trump said he favours a low interest rate policy.
Elsewhere, a week tomorrow, the BoE’s Monetary Policy Committee meet and the BoE will also publish its Inflation Report and update its economic forecasts post-Brexit. The BoE has been part of the consensus view that Brexit is bad, though the effects so far seem to be on published measures of business and consumer confidence. This is not surprising given the ‘Project Fear’ campaign in the run-up to the referendum. The BoE’s own agents’ summary of business conditions suggested little economic impact and this week’s CBI industrial trends survey was surprisingly upbeat on both output expectations and export orders.
International investors are taking advantage of the fall in the sterling exchange rate to purchase UK companies (Softbank-ARM) and buy commercial property. GlaxoSmithKline this morning announced plans to invest GBP 275mn at manufacturing sites in the UK. Note that net speculative short positions are now at an extreme and suggest that the exchange rate might be subject to potential short-covering. Brexit fears of a UK recession are clearly exaggerated and a case can be made for the BoE not to carry out further monetary easing. Indeed, press reports that some UK banks are preparing for negative interest rates might be counter-productive as both the ECB and BoJ have found. With gilt yields at record lows, will more QE make much difference?
Barclays announces new trade finance platform for corporate clients
Barclays Corporate Banking has today announced that it is working with CGI to implement the CGI Trade360 platform. This new platform will provide an industry leading end-to-end global trade finance solution for Barclays clients in the UK and around the world.
With the CGI Trade360 platform, Barclays will provide clients with greater connectivity and visibility into their supply chains, allowing them to optimise working capital efficiency, funding and risk mitigation. By utilising cloud based functionality for corporate banking clients, Barclays will also be able to offer a leading client user experience through easy access and real-time integration to essential information, combined with the latest trade solutions as the industry-wide shift to digitisation continues to accelerate.
This move underpins Barclays commitment to supporting the trade and working capital needs of their clients and reinforces a commitment to innovation that has been central to the bank for more than 300 years.
James Binns, Global Head of Trade & Working Capital at Barclays, said: “We are delighted to announce our move to the CGI Trade360 platform and to have started the implementation process. We have a longstanding partnership with CGI, and the CGI Trade360 platform will mean we can continue delivering the best possible trade solutions and service to our clients for many years to come.”
Neil Sadler, Senior Vice President, UK Financial Services, at CGI, said: “Having worked closely with Barclays for the last 30 years, we knew we were in an excellent position to enhance their systems. Not only do we have a history with them and understand how they work, but part of the CGI Trade360 solution includes a proof of concept phase, which is essentially seven weeks of meetings and workshops with employees across the globe to guarantee the product’s efficiency and answer all queries. We’re delighted that Barclays chose to continue working with us and look forward to supporting them over the coming years.”
What’s the current deal with commodities trading?
By Sylvain Thieullent, CEO of Horizon Software
The London Metal Exchange (LME) trading ring has been the noisy home of metals traders buying and selling for over a hundred years. It’s the world’s oldest and largest metals market and is home to the last open outcry trading floor. Recently however, the age-old trading ring, though has been closed during the pandemic and, just a few weeks ago, the LME announced that it will remain so for another six months and that it is taking steps to improve its electronic trading. This news fits in with a growing narrative in commodities about a shift to electronic trading that has been bubbling away under the surface.
Something certainly is stirring in commodities. The crisis has affected different raw materials differently: a weakening dollar and rising inflation risks bode well for some commodities with precious metals being very attractive, as seen by gold reaching all-time highs. Oil on the other hand has had a tough year and experienced record lows from the Saudi-Russia pricing war. It has been a turbulent year, and now prices look set to soar. While a recent analyst report from Goldman Sachs predicts a bullish market in commodities for the year ahead, with the firm forecasting that it’s commodities index will surge 28%, led by energy (43%) and precious metals (18%).
Increasingly, therefore, it seems that 2020 is turning out to be a watershed moment for commodities, and it’s likely that the years ahead will bring about significant transformation. And whilst this evolution might have been forced in part by coronavirus, these changes have been building up for some time. Commodities are one of the last assets to embrace electronic trading; FX was the first to take the plunge in the 90s, and since then equities and bonds have integrated technology into their infrastructure, which has steadily become more advanced.
The slow uptake in commodities can be explained by several truths: the volumes are smaller and there is less liquidity, and the instruments are generally less exotic, essentially meaning it has not been essential for them to develop such technology – at least not until now. This means that, for the most part, the technology in commodities trading is a bit outdated. But that is changing. Commodities trading is on the cusp of taking steps towards the levels of sophistication in trading as we see in other asset classes, with automated and algo trading becoming ever prominent.
Yet, as commodities trading institutions are upgrading their systems, they will be beginning to discover the extent of the job at hand. It’s no easy task to upgrade how an entire trading community operates so there’s lots to be done across these massive organisations. It requires a massive technology overhaul, and exchanges and trading firms alike must be cautious in the way they proceed, carefully establishing a holistic, step-by-step implementation strategy, preferably with an agile, V-model approach.
The workflow needs to be upgraded at every stage to ensure a smooth end-to-end trading experience. So, in replacement of the infamous ring, these players will be looking to transform key elements of their trading infrastructure, including re-engineering of matching engines and improving communications with clearing houses.
However, these changes extend beyond technology. For commodities players to make a success of the transformation in their community, exchanges need to have highly skilled technology and change the very culture of trading. All of which is currently being done against a backdrop of lockdown, which makes things much more difficult and can slow down implementation.
What is clear is that coronavirus has definitely acted as a catalyst for a reformation in commodities. It is a foreshadowing of what lies ahead for commodities trading infrastructure because, a few years down the line, commodities trading could well be very different to how it is now, and the trading ring consigned to history.
Afreximbank’s African Commodity Index declines moderately in Q3-2020
African Export-Import Bank (Afreximbank) has released the Afreximbank African Commodity Index (AACI) for Q3-2020. The AACI is a trade-weighted index designed to track the price performance of 13 different commodities of interest to Africa and the Bank on a quarterly basis. In its Q3-2020 reading, the composite index fell marginally by 1% quarter-on-quarter (q/q), mainly on account of a pull-back in the energy sub-index. In comparison, the agricultural commodities sub-index rose to become the top performer in the quarter, outstripping gains in base and precious metals.
The recurrence of adverse commodity terms of trade shocks has been the bane of African economies, and in tracking the movements in commodity prices the AACI highlights areas requiring pre-emptive measures by the Bank, its key stakeholders and policymakers in its member countries, as well as global institutions interested in the African market, to effectively mitigate risks associated with commodity price volatility.
An overview of the AACI for Q3-2020 indicates that on a quarterly basis
- The energy sub-index fell by 8% due largely to a sharp drop in oil prices as Chinese demand waned and Saudi Arabia cut its pricing;
- The agricultural commodities sub-index rose 13% due in part to suboptimal weather conditions in major producing countries. But within that index
- Sugar prices gained on expectations of firm import demand from China and fears that Thailand’s crop could shrink in 2021 following a drought;
- Cocoa futures enjoyed a pre-election premium in Ghana and Côte d’Ivoire, despite the looming risk of bumper harvests in the 2020/21 season and the decline in the price of cocoa butter;
- Cotton rose to its highest level since February 2020 due to the threat of storm Sally on the US cotton harvest, coupled with poor field conditions in the US;
- Coffee rose 10% as La Nina weather conditions in Vietnam, the world’s largest producer of Robusta coffee, raised the possibility of a shortage in exports.
- Base metals sub-index rose 9% due to several factors including ongoing supply concerns for copper in Chile and Peru and strong demand in China, especially as the State Grid boosted spending to improve the power network;
- Precious metals sub-index, the best performer year-to-date, rose 7% in the quarter as the demand for haven bullion continued in the face of persistent economic challenges triggered by COVID-19 and heightening geopolitical tensions. In addition, Gold enjoyed record inflows into gold-backed exchange traded funds (ETFs) which offset major weaknesses in jewellery demand.
Regarding the outlook for commodity prices, the AACI highlights the generally conservative market sentiment with consensus forecasts predicting prices to stay within a tight range in the near term with the exception of Crude oil, Coffee, Crude Palm Oil, Cobalt and Sugar.
Dr Hippolyte Fofack, Chief Economist at Afreximbank, said:
“Commodity prices in Q3-2020 have largely been impacted by COVID-19. The pandemic has exposed global demand shifts that have seen the oil industry incur backlogs and agricultural commodity prices dwindle in the first half of the year. The outlook for 2021 is positive however conservative the markets still are. We hope to see an increase in global demand within Q1 and Q2 – 2021 buoyed by the relaxation of most COVID-19 disruptions and restrictions.’’
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