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Summer Volatility Brings Fall Worries

andy bush

Since July 1st, we’ve had dramatic movements in the financial markets that have been astounding.  The S&P fell from 1340 to 1102 as a low and then rebounded to 1,230. This is a 17% fall with a 12% rebound, all within two months.  The US dollar against the Canadian dollar rose from 0.94 to 1.00 and then back to 0.9730. The US Treasury 30 year bond had a 100 bp drop in yields and the two year note had a 30 bp drop in yield. This type of volatility reminds many market participants of the 2008 global financial crisis. The challenging question remains:  what changed in July that made us go through these huge disruptions and dislocations within the market?
First and foremost, growth is not accelerating in the United States as we entered into the second half of the year. This is particularly striking given that many

Summer Volatility Brings Fall Worries 1
Andy Busch,
Global Currency
and Public Policy Strategist
BMO Capital Markets

economists and strategists had predicted strong US economic growth due to the extension of the Bush tax cuts and the cut in the payroll tax. On July 8th, we had weaker than expected non-farm payroll and unemployment data. Then on July 29th, we had an extremely weak US Q1 GDP revision from +1.9% to +0.4% and Q2 GDP data was 1.3% versus expectations of 1.8%. (And, historical data were revised lower to show that the recession was deeper than initially reported.) On August 2nd, personal spending fell for the first time in 2 years and underscored the distressed nature of the US consumer.
Therefore, we’ve had a sharp shift in expectations over future growth with macro-strategists reducing their growth expectations for the end of 2011 and for 2012 between 0.5-1.0 percent. In turn, this shift led to selling of equities due to the reduced growth prospects.
Next, European political problems and the debt problems deepened since July 1st. This lead to European votes on expansion of the European Financial Stability Facility or EFSF, votes on a new Greek bailout package and a vote in Greece over new austerity measures. The process created a miasma of uncertainty for the financial markets and further reduced expectations of future growth.
Also, the United States political environment was unstable and this created negative conditions surrounding the debt ceiling hike in early August. Afterwards, the decision by Standard and Poor’s rating agency to downgrade the United States from AAA was a major negative surprise. This led to a cascading effect with additional downgrades from agency debts to municipal debt to even Warren Buffet’s Berkshire Hathaway. In turn, the markets began to reassess the remaining AAA rated countries for a potential downgrade. This led to France and then led to questions raised over French banks. This negative feedback loop is analogous to what occurred during the 2008 financial crisis as the markets froze up due to counter-party risk.
This is what drove the financial market upheaval and ructions into early August.  Fortunately, the world doesn’t stay the same for very long and policymakers stepped in to stabilize the markets. First, Europeans did change the European Financial Stability Facility. They’ve increased the size and critically allowed for member countries to borrow from the fund to lend to their banks for capital injections. This will eventually reduce the counterparty risk issue, but only after it’s ratified. Next, the European Central Bank agreed to expand what they call their SMP or their sovereign bond buying program, to include Italy and Spain.  This has had the salubrious effect as bond yields in those countries dropped quickly after the announcement. Subsequently, both Italy and France have worked on new austerity measures to reduce their budget deficits which further have reduced fears over funding issues.
On August 4th, the Bank of Japan intervened unilaterally in the currency markets to buy US dollars against Japanese yen to lessen the Risk-Off trading in the markets. The Japanese Ministry of Finance announced a new program on August 24th to spur Japanese spending on foreign corporate acquisitions and resources. The government will send foreign currency reserves to an agency which in turn will make loans to commercial banks. Remember, the stronger yen hurts Japanese exporters as it makes their goods less competitive and reduces the value of their overseas earnings.
Switzerland has been one of the countries that have been severely impacted by the market volatility. Market participants bought the Swiss franc as a flight to safety and this created enormous volatility against the Euro currency with fluctuations of over 10%. On August 17th, the Swiss National Bank (SNB) responded by expanding the supply of funds to their money markets by 200 billion francs and said it would take additional steps if needed. Finally, the SNB has discussed pegging the Swiss franc to the euro and a leading Swiss business group supported the move.
In the United States, Congress and the White House agreed to a compromise deal to increase the US debt ceiling by $2.1 trillion to avoid default. Also, the deal cuts discretionary spending by $917 billion over ten years and establishes a process to cut an additional $1.2-1.5 trillion over the next ten years which, if not done, would set off an automatically triggered round of cuts. While this structure didn’t stop S&P from their downgrade, Fitch and Moody’s didn’t follow S&P and therefore the markets didn’t react by selling US Treasury securities.
Another major stabilizer for the markets was the action by the Federal Open Market Committee (FOMC) to change the language of their monetary policy statement. On August 9th, the FOMC stated:
To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.
The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate.
These highlighted changes reassured the markets that the central bank would continue to engage in easy monetary policy to assist the US economy.
In summary, the financial markets in July and August of 2011 have had thrilling moves to both the downside and upside. Market expectations over future global growth have shifted as US GDP and consumer spending data disappointed to the downside. Also, political events and critical votes created conditions for heightened uncertainty. Finally, policy makers across the globe reacted to the temblors by easy monetary policy or by enacting austerity measures to reassure queasy financial markets. Further policy actions will be warranted to maintain the recent snap back in global stock prices, but it is comforting to know that world did not come to an end at the beginning of August.
To learn how BMO Capital Markets can help you achieve your ambitions, email us at [email protected], or visit www.bmocm.com/fx for a list of contacts in your area.

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Trading

Economic recovery likely to prove a ‘stuttering’ affair

Economic recovery likely to prove a ‘stuttering’ affair 2

By Rupert Thompson, Chief Investment Officer at Kingswood

Equity markets continued their upward trend last week, with global equities gaining 1.2% in local currency terms. Beneath the surface, however, the recovery has been a choppy affair of late. China and the technology sector, the big outperformers year-to-date, retreated last week whereas the UK and Europe, the laggards so far this year, led the gains.

As for US equities, they have re-tested, but so far failed to break above, their post-Covid high in early June and their end-2019 level. The recent choppiness of markets is not that surprising given they are being buffeted by a whole series of conflicting forces.

Developments regarding Covid-19 as ever remain absolutely critical and it is a mixture of bad and good news at the moment. There have been reports of encouraging early trial results for a new treatment and potential vaccine but infection rates continue to climb in the US. Reopening has now been halted or reversed in states accounting for 80% of the population.

We are a long way away from a complete lockdown being re-imposed and these moves are not expected to throw the economy back into reverse. But they do emphasise that the economic recovery, not only in the US but also elsewhere, is likely to prove a ‘stuttering’ affair.

Indeed, the May GDP numbers in the UK undid some of the optimism which had been building recently. Rather than bouncing 5% m/m in May as had been expected, GDP rose a more meagre 1.8% and remains a massive 24.5% below its pre-Covid level in February.

Even in China, where the recovery is now well underway, there is room for some caution. GDP rose a larger than expected 11.5% q/q in the second quarter and regained all of its decline the previous quarter. However, the bounce back is being led by manufacturing and public sector investment, and the recovery in retail sales is proving much more hesitant.

China is not just a focus of attention at the moment because its economy is leading the global upturn but because of the increasing tensions with Hong Kong, the US and UK. UK telecoms companies have now been banned from using Huawei’s 5G equipment in the future and the US is talking of imposing restrictions on Tik Tok, the Chinese social media platform. While this escalation is not as yet a major problem, it is a potential source of market volatility and another, albeit as yet relatively small, unwelcome drag on the global economy.

Government support will be critical over coming months and longer if the global recovery is to be sustained. This week will be crucial in this respect for Europe and the US. The EU, at the time of writing, is still engaged in a marathon four-day summit, trying to reach an agreement on an economic recovery fund.  As is almost always the case, a messy compromise will probably end up being hammered out.

An agreement will be positive but the difficulty in reaching it does highlight the underlying tensions in the EU which have far from gone away with the departure of the UK. Meanwhile in the US, the Democrats and Republicans will this week be engaged in their own battle over extending the government support schemes which would otherwise come to an end this month.

Most of these tensions and uncertainties are not going away any time soon. Markets face a choppy period over the summer and autumn with equities remaining at risk of a correction.

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Trading

European trading firms begin coming to terms with the new normal

European trading firms begin coming to terms with the new normal 3

By Terry Ewin, Vice President EMEA, IPC

In recent weeks, the phrase ‘never let a good crisis go to waste’ has received a large amount of usage. Management consultancies, industry associations and organisations, including the Organisation for Economic Co-operation and Development (OECD) have all used it in order to discuss how the current crisis, caused by the Coronavirus pandemic, presents an opportunity for new and worthwhile change.

The saying is also commonly used to indicate that the destruction and damage that is caused by a crisis gives organisations the chance to rebuild, and to do things that would not have previously been possible. This has the potential to impact financial trading firms, where projects that this time last year would not have made much sense now appearing to be as clear as day. In Europe, banks and brokers alike are beginning to think about what life will look like post-pandemic, and how their technology strategies may need changing.

We can think of three distinct phases when it comes to a crisis. Firstly, there is the emergency phase. This is followed by the transition period before we come to the post-crisis period.

Starting with the emergency phases, this is when firms are in critical crisis management mode. Plans are activated to ensure business continuity, and banks and brokers work to ensure critical functions can still take place so as to continue servicing their clients. With regards to the current crisis period, both large and small European banks and brokers were able to handle this phase relatively well, partly due to the fact that communications technology has reached the point where productive Work From Home (WFH) strategies are in place. For example, cloud-connectivity, in addition to the use of soft turrets for trading, has enabled traders from across the continent to keep working throughout lockdown. From our work with clients, we know that they were able to make a relatively smooth transition to WFH operations.

In relation to the current coronavirus crisis, we are in the second phase – the transition period. This is the stage when financial companies begin figuring out how best to manage the worst effects of the ongoing crisis, whilst planning longer-term changes for a post-crisis world. One thing to note with this phase, is that no one knows how long it will last. There is still so much we don’t know about this virus. As such, this has an impact on when it will be safe for businesses to operate in a similar way to how they were run in a pre-pandemic world. But with restrictions across Europe starting to be eased, there is an expectation that companies will start to slowly work their way towards more on-site trading. For example, banks are starting to look at hybrid operations, whereby traders come in a couple of times a week, and WFH for the rest of the week. This will result in fewer people in the office building, which makes it easier to practise social distancing. It also means that there is a continued reliance on the technology that enables people to WFH effectively.

Finally, we have the post-crisis period. In terms of the current crisis, this stage is very unlikely to occur until a vaccine has been developed and distributed to the masses. Although COVID-19 has caused mass economic disruption, many analysts are predicting a strong rebound once the medical pieces of the puzzles are put into place. It may not be entirely V-shaped, but the resiliency displayed by the financial markets thus far suggests that it will be healthy.

Currently, many European trading firms are taking what could be described as a two-pronged approach.

The first part of this consists of planning for the possibility of an extension to phase two. Medical experts have suggested that there could be some seasonality to the virus, with the threat of a second wave of COVID-19 cases in the Autumn meaning that the risk of new restrictions remains. If this comes to fruition, there would be a need for organisations to fine-tune their current WFH strategies and measures, and for them to take greater advantage of the cloud so as to power communications apps.

The second component consists of firms starting to think about the long-term needs of their trading systems. Simply put, they are preparing themselves for the third phase.

It is in this last sense, that the idea of never letting ‘a good crisis go to waste’ resonates most clearly.

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Trading

Currency movements and more: How Covid-19 has affected the financial markets

Currency movements and more: How Covid-19 has affected the financial markets 4

The COVID-19 pandemic has been more than a health crisis. With people forced to stay indoors and all but the most essential services stopped for multiple weeks, economies have suffered and financial markets have crashed. Perhaps the most public and spectacular fall from grace during the early stages of the pandemic was oil. With travel bans in place around the world and no one filling up at the pumps, the price of oil plummeted.

Prior to global lockdowns, US oil prices were trading at $18 per barrel. By mid-April, the value had dropped to -$38. The crash was not only a shocking demonstrating of COVID-19’s impact but the first time crude oil’s price had fallen below zero. A rebound was inevitable, and many traders were quick to take long positions, which meant futures prices remained high. However, with stocks piling up and demand sinking, trading prices suffered. Unsurprisingly, it’s not the only market that’s taken a knock since COVID-19 struck.

Financial Markets Fluctuate During Pandemic

Shares in major companies have dipped. The Institute for Fiscal Studies compiled a round-up of price movements for industries listed by the London Stock Exchange. Tourism and Leisure have seen share prices drop by more than 20%. Major airlines, including BA, EasyJet and Ryanair have all been forced to make redundancies in the wake of falling share prices. The automotive industry has also taken a knock, as have retailers, mining and the media. However, in among the dark, there have been some patches of light.

The forex market has been a mixed bag. As it always is, the US dollar has remained a strong investment option. With emerging markets feeling the strain, traders have poured their money into traditionally strong currency pairs like EUR/USD. Looking at the data, IG’s EUR/USD price charts show a sharp drop in mid-March from 1.14 to 1.07. However, after the initial shock of COVID-19 lockdowns, the currency pair has steadily increased in value back up to 1.12 (June 25, 2020). The dominance of the dollar has been seen as a cause for concern among some financial experts. In essence, the crisis has highlighted the world’s reliance on it.

Currency Movements Divide Economies

Currency movements and more: How Covid-19 has affected the financial markets 5

In any walk of life, a single point of authority is dangerous. Indeed, if reliance turns into overreliance, it can cause a supply issue (not enough dollars to go around. More significantly, it could cause a power shift that gives the US too much control over economic policies in other countries. Fortunately, other currencies have performed well during the pandemic. Alongside USD and EUR, the GBP has also shown a degree of strength throughout the crisis. However, these positive movements haven’t been shared by all currencies.

The South African rand took a 32% hit during the early stages of the pandemic, while the Mexican peso and Brazilian real dropped 24% and 23%, respectively. Like the forex market, other sectors have experienced contrasting fortunes. Yes, shares in airlines and automotive manufacturers have fallen, but food and drug retailers have seen stocks rise. In fact, at one point, orange juice was the top performer across multiple indices. With the health benefits of vitamin C a hot topic, futures prices for orange juice jump up by 30%. The sudden surge had analysts predicting 60% gains as we move into a post-COVID-19 world.

Looking Towards the Future through Financial Markets

The future is always unknown and, due to COVID-19, it’s more uncertain than ever. However, the financial markets do provide an indication of how things may change. The performance of USD and EUR in the forex markets suggest there could be a lot more trade deals negotiated between the US and Europe. The surge in orange juice futures suggest that health and wellness will become a much more important part of our lives. Even though it was already a multi-billion-dollar industry, the realisation that a virus can alter the face of humanity has given more people pause for thought.

Then, of course, there’s the move towards remote working and socially distance entertainment. From Zoom to Slack, more people will be working and playing from home in the coming years. The world is always changing, but recent have events have made us appreciate this fact more than ever. The financial markets aren’t a crystal ball, but they can offer a glimpse into what we can expect in a post-COVID-19 world.

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