By Graham Bishop, Investment Director at Heartwood Investment Management
Our view of a slight softening in global economic momentum in the second half of the year remains unchanged, alongside our expectation of moderately rising inflation trends over coming months. Central banks are likely to continue on (or begin) their journey of normalising monetary policy, which we believe is a scenario that financial markets are not yet fully pricing. Risk appetite remains reasonably buoyant and market volatility very low, albeit there has been a moderate increase more recently on geopolitical concerns. We are mindful that the current benign fundamental backdrop of moderate growth, low interest rates and low inflation is leading to a certain amount of complacency in markets. Our concern is that any deterioration in the growth/inflation story could prompt profit-taking and challenge this more sanguine view of the world. We continue to believe that monetary policy remains a key trigger for caution, notwithstanding that central banks have stepped back from their hawkish signals provided in recent weeks. In our view, the risk/reward dynamic of risk assets is not as favourable compared with the start of the year and we believe it is appropriate to stay with our risk reduction plan. This will be focused on UK property, given potential liquidity issues in the event of any sell-off. Overall, we are taking a measured approach in reducing risk and maintaining flexibility to re-calibrate portfolios in either direction should economic and market conditions change.
Equities: Emerging market (EM) indices were particularly strong in July, boosted by the weak US dollar. US, UK and Asian indices have also put in respectable return. We are retaining our overweight in European equities for now, but we are more cautious about this market given very strong currency moves. Conversely, the weakness of the US dollar is a boost to the corporate sector, so we are happy to run our existing US equity weight (but still preferring a more targeted approach). We remain concerned about economic slowdown in the UK and broader policy backdrop (Bank of England, Brexit and domestic politics). We would not repatriate to the UK, nor would we increase domestic versus overseas UK equities right now. Elsewhere, we are comfortable with retaining our overweight positions in Japanese and EM equities.
Bonds: A less hawkish backdrop drove global bond yields lower in July. Rate expectations remain dovish and look most vulnerable to a re‐pricing in the US and Europe. Therefore, our caution towards maintaining a short duration position remains intact. Break-even rates (the difference between nominal fixed-rate bonds and the inflation-adjusted yield on an inflation-linked bond) are falling in the UK, but are recovering to some degree in the US and Europe, which is consistent with the fundamental backdrop. Credit spreads have been supported by the ‘goldilocks growth’ backdrop, and in some areas are back to or close to the tights in 2014.
Property: We have marginally reduced our UK property allocation further, comprising part of our risk reduction plan, as well as to address issues around investment trust premiums and liquidity withdrawal, given the maturity of the current cycle. We also believe an underweight stance is appropriate in light of UK political uncertainties. While activity has slowed and there are questions about rent sustainability, our regional bias and reasonable discounts on certain instruments will provide some protection in the event that market yields move higher. At this stage, there is no appetite to add overseas exposure.
Commodities: Markets were resilient in July, continuing the gains that began in mid‐June. Negative news about oil inventories has faded, although demand remains sluggish. We believe there is limited room for oil prices to go much higher from here, especially given rising output in Libya and with the end of OPEC supply cuts coming in the first quarter of 2018. Industrial metals have performed well, although this appears to be supply-driven rather than due to rising demand. Meanwhile, precious metals have been helped by US dollar weakness and lower real yields – factors which we think are unlikely to persist. We retain our underweight allocation in commodities, although we are maintaining our exposure to gold for portfolio diversification.
Hedge funds: While we have held a limited allocation to hedge funds in recent years on concerns around performance, we believe that increasing monetary policy divergence should create more opportunities in this sector going forward. Our preference remains for macro/CTA strategies, but we are also taking a more positive view on equity hedge strategies given the greater likelihood of increased stock dispersion (i.e. between winners and losers).
Cash: We have reasonable levels of liquidity across our portfolios both in cash and short-dated bonds, which we will invest as and when we see specific opportunities. Market volatility remains low – a situation that we believe is unlikely to persist as we move into the second half of the year.
What we can expect from currencies and markets in 2021
By Jeremy Thomson-Cook, Chief Economist at money management specialist Equals Money, part of the Equals Group.
2020 was a year that changed almost every aspect of our lives, and currency markets across the world reacted with volatility. Complacency, panic, and isolation have influenced activity over the last 12 months and most recently, a semblance of hope has been seen as vaccines offer the first glimpse of a ‘way out’.
While 2021 will hopefully see us on the road to recovery, we’re certain to be dealing with the longer-term economic effects of the pandemic for years to come, while also navigating a post-Brexit outlook. So, what can we expect from currencies and markets in 2021?
A focus on recovery
Once the impact of mass-vaccination starts to be seen across the world, we expect to see a huge focus on recovery this year.
Investors are expected to move away from considering the US dollar and wider developed markets as the best place for their money, with an increased interest in emerging markets. Commodity prices are likely to remain high as demand recovers and the global supply chain gains pace due to growing confidence from consumers to spend their cash.
Successful logistics will play a pivotal role on the road to recovery, with the ability of governments to both reliably and speedily vaccinate the population while driving the global economy from a trade point of view, essential for success.
All this is underpinned by the assumption that interest rates will remaining at ultra-low levels throughout this year, and in certain cases, longer still.
When it comes to sector-specific recovery, the travel, airline, and leisure industries are expected to make a strong comeback when restrictions ease as consumers look to make up for lost time.
By contrast, commercial property and real estate are likely to face challenges as businesses revaluate how they use office space after nearly a year of successful remote working. This struggle will also be reflected by the increasing amount of empty retail space on British highstreets after the sector, and some of Britain’s most established brands, were hit hard in 2020.
What will we see from currencies across the globe?
The pound is reacting to a UK economy still very much in the grips of a pandemic, with strict lockdown measures likely to be in place until at least March. Add to that a new relationship with the European Union, and we’re likely to see the pound underperform in 2021, particularly against the euro.
Politics is likely to have less sway over sterling in 2021, with the exception of the upcoming elections in Scotland which are likely to raise the chances of another Sottish referendum on independence.
Despite the expectation that the pound will have a modest year, we do expect to see it move higher against the US dollar in the coming months.
All signs point to a strong start for the euro, and we expect it will continue the strength it showed at the end of 2020 for the months to come. Its counterparts in Scandinavia (NOK, SEK) and in Central and Eastern Europe (PLN, HUF) may even outperform the single currency as the Eurozone recovery outpaces the US and UK’s.
Markets are pleased that the Eurozone has managed to come together during a time of crisis and offer businesses and consumers both fiscal and monetary policy support. The political agenda looks a lot quieter for 2021, and this lack of political pressure coupled with a central bank that has shown its strength through the Pandemic Emergency Purchase Program, means sovereign risk is very low.
The US dollar is likely to remain weak as investors who have bought into the dollar during Trump’s tenure in the White House react to the transition to a Biden Administration – a change that is likely to normalise global trade and expand spending.
US businesses have struggled with international relations under the watch of a Trump administration and a calmer stewardship of trade should help to boost corporate profits in the coming months, allowing for further USD depreciation.
If the UK, Asia or the Eurozone are able to move forward with their pandemic recovery faster than the US, we expect the dollar to lag against both GBP and EUR, as well as other emerging currencies – the Chinese yuan, Russian ruble and Indonesian rupiah – in 2021.
The Japanese yen has acted as a safe haven from negative investment sentiment throughout the Covid-19 pandemic, and arguably long before that, pushing higher against other currencies in 2020.
While the yen would typically be sold off by investors in favour of more attractive investments, the overall outlook becomes more positive as it continues to show strength as we enter 2021. This could be down to the strange markets that we are currently navigating; vaccine joy tempered by very real near-term pandemic problems. Investors may also be positioning themselves for a wider retreat in the US dollar (USD).
Whilst the Japanese yen may enjoy some strength against the USD in the coming year and remains one to watch, we expect it to slip on a broader basis.
The Australian dollar has acted as a poster child for the recovery in risk assets since the early days of the pandemic, and its likely to remain ahead of its counterparts for the early part of the year.
Australia’s handling of the pandemic to date gives it an advantage over the likes of the UK and US, and as it enters the summer months with a vaccine rollout all but underway, the outlook is positive.
If market minds are focused on a recovery then we will be looking for a higher AUD, and it is not out of the realms of possibility that it could outperform the majority of the G10.
If 2020 taught us anything, it’s that nothing’s set in stone and as we start the new year in another lockdown, it looks like that’s set to continue for 2021. Either way, we’ll see the uncertainty of the world we live in continue to be reflected in the market and currency activity across the globe.
Trial by fire: Why 2020 experience will help the FX industry in 2021
By Vikas Srivastava, Chief Revenue Officer at Integral
I think I can say with confidence that 2020 has been the strangest year in my career to date. The FX markets have faced their fair share of geopolitical disruptions over the decades, yet nothing comes close to the impact of COVID-19. While we are not out of the woods yet, there are reasons to be optimistic about 2021.
As with many other industries, the last ten months has created the necessary conditions for innovation in FX by accelerating existing trends. Due to enforced lockdowns and distributed workforces, we now have many buy and sell-side institutions undertaking a greater proportion of electronic and algorithmic trading, automated workflows, and off-premise solutions. These trends are gaining pace, ensuring the FX industry has not simply coped but adopted and overcome during these difficult conditions.
It’s a good thing the market is in a position of quiet confidence as 2021 will not be a walk in the park. Along with contending with a low-rate environment and geopolitical uncertainty, new regulations will be introduced for the first time or as part of previous phases that were postponed due to the pandemic. Both SA-CCR and phase 5 of the uncleared margin rules (UMR) introduce greater cost implications for certain trades and introduce new headaches for OTC markets in particular.
With unavoidable events appearing on the horizon, institutions need to assess their technology to ensure they can continue supporting their clients irrespective of where we are working and the market conditions surrounding us. Cloud technology that is fast-to-implement and offers highly customizable features will allow institutions to keep up with accelerating trends and offer bespoke solutions to clients, all at significantly lower cost and without the need to compromise on quality.
Having learnt the lessons of the last year, the FX industry is in a strong position to push on again in 2021. To do so successfully, firms will need to maintain their ambition in innovating and introducing cost and operationally efficient technology. Those that do can fly high up in the clouds – no pun intended.
Capital Markets: The Last Frontier for Digital Transformation in Financial Services
By Dr. Avtar Singh Sehra, CEO, Nivaura
The last decade has seen financial services undergo vast digital transformation. New technologies and a greater ability to digitise and automate processes have brought greater efficiency and effectiveness to the sector, as well as enabling the creation of new, value-added consumer and B2B products.
Capital markets, however, remain largely unchanged. The industry is constrained by legacy processes that often involve substantial manual data input and document/spreadsheet management, which is inefficient in comparison to digital and automated operations. These inefficiencies have been squeezing capital market participants’ margins for far too long.
The current state of affairs
As it stands, a typical primary capital markets execution is a linear and sequential process involving multiple stakeholders, who repeatedly convey information back and forth manually to draft and execute legal documents, and then manage data input into multiple systems. This data is then sent across multiple institutions across the transaction lifecycle from pre-trade to post-trade, where it is again extracted and transformed to perform further lifecycle management activities. The processes that occur after drafting relevant documentation, such as clearing and record-keeping, are also manual and time consuming, with parties having to review documents individually.
There are some exceptions to this. For example, within commercial paper and certificates of deposit, there is some level of automation in how deals are executed, and data is transmitted from a dealer into post trade processes. In addition, high volume, structured, self-led transactions may be standardised to some degree. However, even with these isolated islands of partial automation, the general debt capital markets (DCM) issuance process remains highly manual and is in desperate need of digitisation and automation to increase its effectiveness and efficiency.
Not only do these repeated manual processes require significant human resources, but they are also prone to error. Humans, for all our gifts compared to machines, will never be able to achieve consistent 100% accuracy when it comes to complex data and document management processes. However, before we can even begin to discuss automating manual activities, they must first be digitised. This is crucial because it enables the capture of structured data throughout the transaction lifecycle. Only structured data can be easily leveraged for advanced automation, from simple if-then logic, to advanced machine learning technologies for complex cognitive decision making e.g., extracting data from complex documents.
Considering the evolution that the rest of the financial sector has undergone over the last twenty years when it comes to digitisation and automation, it’s hard to understand why capital markets have been left behind until now. But change is finally coming.
A turning point
2020 saw the winds of change begin to blow across the capital markets industry. In a first for the sector, a group representing all participants of primary capital market transactions is collaborating on a data standard to be used in legal documents as well as down-stream systems and transactions data flow: General-purpose Legal Mark-up Language (GLML). This collaboration is taking place under the umbrella of the GLML Consortium, whose founding members include magic circle law firms and capital markets infrastructure technology vendors.
GLML is a ‘mark-up language’: a type of human and machine-readable syntax developed to be easy for a lawyer (or, indeed, anyone else) to implement in documentation with little training, and without requiring coding experience. It enables users to easily turn their existing contractual templates, including precedents and pro formas, into machine readable files, which can then be used to create transactions with structured data from the outset that can map to a standardized taxonomy for transmission across the pre- or post-trade process. Any word processor or editor (including Microsoft Word) can be used to apply GLML, allowing drafters to create and maintain “GLML’d” templates in the same way they approach traditional documentation.
Fundamentally, GLML permits the accurate extraction of key data from legal documentation, allowing it to be passed to relevant intermediaries in a standard and automated and seamless manner.
The wider implications of GLML
At first glance, it’s easy to underestimate the impact that a standard like GLML could have on the capital markets industry, but enormous benefits come from what it will enable.
First, GLML enables the accurate creation of structured data, which is usually produced and executed in an unstructured way in debt capital markets transactions. GLML therefore allows data to be passed between relevant transaction participants and financial market infrastructures automatically and seamlessly, and thus easily mapped to other formats. This alone will make capital markets workflows much more efficient, increasing profit margins and freeing up human resources to focus on value-add tasks and projects. Furthermore, as the volume of structured data increases, we gain further capabilities to enable increasing automation using AI tools.
Second, GLML enables capital markets participants, from dealers and borrowers to lawyers, to communicate easily, and collaborate throughout the capital raising process on digital platforms. This again reduces human error caused by data input, extraction and transformation.
Third, but perhaps most importantly, is that GLML as an open standard drives expansion of the ecosystem and enables innovation. For example, if one were to invest in digitising and automating all their capital markets documents through “low-code” or “no-code” tools, they would be locked into one vendor’s tools and standards. This means that, as the industry changes and new services emerge, or if you simply want to convert generated data to other formats, significant further effort is required. This slows down adoption of such tools and makes communication and interactions between multiple parties more challenging.
It is accepted that a lack of standards creates friction in a market, which limits interaction, flexibility, agility and innovation. One of the most obvious examples of this is seen in the emergence of the World Wide Web, which is underpinned by HTTP/HTML and led to the explosive adoption of the internet in the 90s. We can even go further back than this, where the lack of “standard”, or, more accurately, lack of a common railway gauge (rail width), led to significant challenges in the early railways. When a line of one gauge met a line of a different gauge, trains couldn’t run through without some form of conversion, which would normally lead to passengers having to change trains. This resulted in significant delays, inconvenience and cost. Widespread adoption of railways globally did not come until a standard gauge was created.
GLML will achieve for capital markets what HTTP did for the internet. It will support the simplification and ultimately democratisation of capital markets, ensuring the demand for capital can be efficiently and effectively connected to the supply.
GLML, as an open data standard, is the first step to digitising and automating the lifecycle of the issuance process. Today, capital markets processes are outdated, leading to vast and unnecessary cost and risk. Evolution is both essential and inevitable and, driven by GLML, 2021 will be the year that the debt capital markets transform for good as the industry converges around a common standard.
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