By George Vessey, Currency Strategist at Western Union
Volatility and uncertainty
As a turbulent year draws to a close, being ready for whatever lies ahead is more important than ever for businesses, however knowing how to be fully futureproofed is tough. The rise of geopolitical themes such as trade wars, and the growing influence of political figures on financial markets, have gradually but significantly increased the complexity around judging future market trends and their implications for international business. Now, adding COVID-19 to the mix has brought a whole new dimension to global markets analysis.
The pandemic has triggered a broad and rapid disruption to economies, technology and infrastructure worldwide. The global business arena is now under enormous pressure to bounce back. After all, the world is still living through its most severe economic downturn in modern history. Amidst the Great Lockdown, more than 90% of countries could experience an annual economic contraction, while emerging markets collectively are at risk of recording their first year without growth in at least 60 years. The timing of a return to pre-crisis economic levels remains highly uncertain and reliance on the success of newly developed vaccines gives the recovery a more binary character which polarizes any forecasts for next year. Fortunately, the positive vaccine developments over recent weeks have boosted recovery prospects and inflated risk appetite across financial markets, prompting a shift in investors’ portfolios towards cyclicals, which should be positive for the UK market.
As we look ahead to 2021, exchange rate volatility jumps to the forefront, given it has a vast impact on the profitability of international trade in goods and services. As companies now transition into the ‘new normal’ and re-structure plans for next year, the risks to financial objectives from economic and currency fluctuations remain acute.
A range of challenges across GBP, USD, EUR and AUD
After years of having relatively higher interest rates, US rates are now in line with other developed nations: near zero. Recently, the dollar has been notching fresh 2 ½-year lows regularly. The rise in risk appetite globally has seen an extension of the rotation of capital from safer assets, like the US Dollar, into riskier higher-yielding investments, like stocks, copper, oil, emerging market and commodity currencies.
Should this dollar-weakening trend continue, 2021 may allow GBP/USD to press into the higher realms of the $1.30s. On the other hand, there aren’t many positive catalysts driving the pound either. Growing speculation about further UK rate cuts may limit sterling upside as negative interest rate policy remains in active review by the BOE. A UK-EU deal, due by 31 December, also remains a major uncertainty, which has the potential to drag GBP/USD back under $1.20.
As to GBP/EUR – the trajectory may largely depend on how successful the global economic recovery is. Will the UK and Europe differ in their recovery speeds, especially bearing in mind the UK’s go-ahead for the Pfizer and BioNTech vaccine? And how will a potential second or third wave of the virus be managed by governments in both areas? The long-lasting impact of coronavirus on the economies of both the UK and the Eurozone may not be realized until late 2020 or even 2021, due to the huge support by policymakers in both regions to help protect jobs and reduce bankruptcies.
A no-trade deal Brexit is also a key risk lingering over both regions, though the UK and thus the pound is expected to suffer more so in the short run. After all, the UK currency’s sensitivity to negative Brexit headlines is significant, with GBP/EUR dropping as soon the media suggests that Brexit trade talks are hanging in the balance. Expectations of GBP/EUR falling towards parity in such a scenario are growing, particularly if it also prompts a Scottish independence referendum. Conversely, a trade deal should help GBP/EUR climb towards €1.20.
The unfolding effect of COVID-19 impacts the Aussie, too. The trajectory of GBP/AUD largely depends on whether a second or third wave of coronavirus scuppers economic recovery hopes and sparks risk aversion across financial markets. Historically, the AUD outperforms the pound during times of economic recovery.
If financial markets reel in the event of a new round of lockdown measures, then investors may ditch high yielding assets, including the Aussie dollar. As per the trend in March, GBP/AUD may drift higher as a result. China plays a key factor here too – with the country embroiled in several economic and geopolitical disputes, including with the UK and Australia. An escalation of these disputes could lead to economic sanctions, posing a serious threat to Australia’s recovery hopes.
Preparation, preparation, preparation
While it is therefore nigh on impossible for businesses worldwide to know exactly what lies ahead, and while there is no one size fits all approach to FX risk management, the overarching objective to achieve cash flow certainty and protect profits from the effects of FX rate movements must remain the same. While future scenario testing and subsequent risk analysis remains an incredible challenge for many companies, this remains vital for many businesses when it comes to navigating currency volatility.
Looking ahead to 2021, it is important that business decision makers stay focused on the basic building blocks of hedge strategy development, and that throughout the festive season and into 2021, tactics employed are regularly reviewed to ensure that every company’s FX risk management objectives continue to be met.
China, New Zealand ink trade deal as Beijing calls for reduced global barriers
By Praveen Menon and Gabriel Crossley
WELLINGTON/BEIJING (Reuters) – China and New Zealand signed a deal on Tuesday upgrading a free trade pact to give exports from the Pacific nation greater access to the world’s second-largest economy.
The pact comes as Beijing seeks to establish itself as a strong advocate of multilateralism after a bruising trade war with the United States, at a time when the coronavirus has forced the closure of many international borders.
New Zealand Prime Minister Jacinda Ardern confirmed the signing of the expanded deal.
“China remains one of our most important trade partners…For this to take place during the global economic crisis bought about by COVID-19 makes it particularly important,” she told a news conference.
The pact widens an existing trade deal with China to ensure it remains fit for purpose for another decade, Trade Minister Damien O’Connor said in a statement.
It provides for tariffs to be either removed or cut on many of New Zealand’s mostly commodities-based exports, ranging from dairy to timber and seafood, while compliance costs will also be reduced.
For a factbox on key deal points, please click on the square brackets:
CHINA’S MULTILATERAL PUSH
“The upgrade shows the two sides’ firm determination to support multilateralism and free trade,” Zhao Lijian, a spokesman of China’s foreign ministry, told a news briefing in Beijing on Tuesday.
The previous day, speaking at a virtual meeting of the World Economic Forum, President Xi Jinping had criticised isolationism and “Cold War” thinking and called for barriers to trade, investment and technological exchange to be removed.
In recent months, Beijing has signed an investment pact with the European Union and joined the world’s largest free trade bloc in the 15-country Regional Comprehensive Economic Partnership (RCEP), which includes New Zealand.
China has also expressed interest in joining the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) Agreement, the successor to a pact from which Washington withdrew.
China’s new deal with Wellington also opens up sectors such as aviation, education and finance. In exchange, New Zealand will increase visa quotas for Chinese language teachers and tour guides, the official Xinhua news agency said.
New Zealand was the first developed nation to sign a free trade pact with China in 2008, and has long been touted by Beijing as an exemplar of Western engagement.
China is now New Zealand’s largest trading partner, with annual two-way trade of more than NZ$32 billion ($21.58 billion).
But ties have been tested under Ardern’s government as New Zealand criticised China’s influence on small Pacific islands and raised human rights concerns about Muslim Uighurs.
Ardern also backed Taiwan’s participation at the World Health Organization (WHO) despite a warning from Beijing.
The wider trade pact also comes as Beijing’s ties with neighbouring Australia worsened after Canberra called for an independent investigation into the origins of the coronavirus pandemic, which was first reported in central China.
Australia has appealed to the World Trade Organization to review China’s decision to impose hefty tariffs on imports of its barley.
New Zealand, which will host the regional Asia Pacific Economic Cooperation summit this year, has said it would be willing to help negotiate a truce between China and Australia.
($1=1.3914 New Zealand dollars)
(Reporting by Praveen Menon; Editing by Aurora Ellis and Sam Holmes)
Cryptocurrencies: the new gold?
By Gerald Moser, Chief Market Strategist, Barclays Private Bank
Time to add to a portfolio?
There has been a lot of talk about bitcoin, and cryptocurrencies in general, being a “digital” gold. Similar to gold, there is a finite amount, it is not backed by any sovereign and no single-entity controls its production. But for bitcoin to be considered in a portfolio and to become an investable asset, similar to gold, the asset would need to improve the risk/return profile of that portfolio. This seems a tall order.
While it is nigh on impossible to forecast an expected return for bitcoin, its volatility makes the asset almost “uninvestable” from a portfolio perspective. With spikes in volatility that are multiples of that typically experienced by risk assets such as equities or oil, many would probably throw the cryptocurrency out of any portfolio in a typical mean-variance optimisation.
And while bitcoin’s correlation measures are relatively supportive, it seems to falter when diversification is most needed, such as during sharp downturns in financial markets. Looking at weekly return correlations since 2016 shows that bitcoin is not strongly correlated with any assets (see below). It is however only second to US high yield in its correlation with equities. US Treasuries, gold and US investment grade were better diversifiers than bitcoin when it comes to equities.
Furthermore, looking at global equity corrections since 2015 (see below), it is noticeable that bitcoin has performed even worse than equities over the last three corrections. And while gold and fixed income provided some relief during those corrections, bitcoin compounded the loss that investors would have incurred from equities exposure.
The fact that cryptocurrencies also fluctuate alongside equities suggests that investment in bitcoin is more akin to a bubble phenomenon rather than a rational, long-term investment decision. The performance of the cryptocurrency has been mostly driven by retail investors joining a seemingly unsustainable rally rather than institutional money investing on a long-term basis.
Several studies around market structure have shown that emerging markets with high retail/low institutional participation are more unstable and more likely subject to financial bubbles than mature markets with institutional participation. And while more leading financial houses seem to be taking an interest in cryptocurrencies, the market’s behaviour suggests that the level of institutional involvement is still limited. Another issue is around its concentration: about 2% of bitcoin accounts control 95% of all bitcoins.
In summary, difficulty to forecast return, lack of diversification and high volatility makes it hard to consider bitcoin as a standalone asset in a diversified portfolio for long-term investors.
An inflation hedge?
Another point widely quoted in favour of cryptocurrencies is that they provide an inflation hedge. This might be a valid point, if inflation stems from fiat currency debasement. As mentioned above, a currency’s worth comes from the trust economic agents have in it. If unsustainable amounts of debt and large money creation shatter belief in sovereign-backed currencies through spiralling inflation, cryptocurrencies could be seen as an alternative.
Regardless of its price, bitcoin’s production is set on a precise schedule and cannot be changed. If oil or copper prices go up, there is an incentive to produce more. This is not the case for cryptocurrencies. In a very specific and highly hypothetical scenario of all fiat currency collapsing, this could be positive. But other real assets such as precious metals, inflation-linked bonds or real estate usually provide a hedge against inflation.
Bitcoin’s technology should theoretically make it extremely secure. As there is no intermediary, each transaction is reviewed by a large number of participants which can all certify the transaction. However, there have been frauds and thefts from exchanges. Another point to consider is the risk of “losing” bitcoins. According to the cryptocurrency data firm Chainanalysis, around 20% of the existing 18.5m bitcoins are lost or stranded in wallets, with no mean of being recovered. As there is no intermediary, there is no backup for a lost bitcoin.
From a sustainability point of view, adding cryptocurrencies to a portfolio will make it less green. Mining and exchanging them is highly energy intensive. According to estimates published by Alex de Vries, data scientist at the Dutch Central Bank, the bitcoin mining network possibly consumed as much in 2018 as the electricity consumed by a country like Switzerland. This translates to an average carbon footprint per transaction in the range of 230-360kg of CO2. In comparison, the average carbon footprint of a VISA transaction is 0.4g of CO2.
Beyond energy use, the mining process generates a large amount of electronic waste (e-waste). As mining requires a growing amount of computational power, the study estimates that mining equipment becomes obsolete every 18 months. The study suggests that the bitcoin industry generates an annual amount of e-waste similar to a country like Luxembourg.
Cryptocurrencies are here to stay
Innovation in digital assets continues rapidly and will likely drive increased participation, both from retail and institutional investors. The underlying blockchain technology behind bitcoin was meant to disrupt a few different industries. While results have not lived up to the initial hype, more sectors are investigating the use of the technology.
And with Facebook announcing a stablecoin, or a cryptocurrency pegged to a basket of different fiat currencies, central banks have accelerated the movement towards central bank digital currencies. Those could improve payment systems resilience and facilitate cross-border payments.
Energy stocks drag down FTSE 100, IG Group slides
By Shivani Kumaresan
(Reuters) – London’s FTSE 100 slipped on Thursday, weighed down by falls in energy stocks as oil prices slid after a surprise increase in U.S. crude inventories, while IG Group tumbled on plans to buy U.S. trading platform tastytrade for $1 billion.
The blue-chip FTSE 100 index lost 0.4%, while the domestically focussed mid-cap FTSE 250 index also slid 0.4%.
Energy majors BP and Royal Dutch Shell fell 3.2% and 2.5%, respectively, and were the biggest drags on the FTSE-100 index. [O/R]
“What is holding back the UK is a lack of tech stocks to capture the ‘rotation’ back into tech seen since Netflix results,” said Chris Beauchamp, chief market analyst at IG.
“Stock markets overall are much quieter today, looking so far in vain for a new catalyst for further upside.”
The FTSE 100 shed 14.3% in value last year, its worst performance since a 31% plunge in 2008 and underperforming its European peers by a wide margin, as pandemic-driven lockdowns battered the economy and led to mass layoffs.
British Prime Minister Boris Johnson said it was too early to say when the national coronavirus lockdown in England would end, as daily deaths from COVID-19 reach new highs and hospitals become increasingly stretched.
IG Group tumbled 8.5% after announcing plans to buy tastytrade, venturing into North America after a stellar year for the new breed of retail investment brokerages.
Ibstock jumped 7.3% to the top of the FTSE 250 after the company said fourth-quarter activity benefited from better-than-expected demand for new houses and repairs.
Pets at Home Group Plc rose 2.2% after reporting an 18% jump in third-quarter revenue, boosted by higher demand for its accessories and veterinary services as more people adopted pets during lockdowns.
(Reporting by Shivani Kumaresan in Bengaluru; editing by Uttaresh.V and Mark Potter)
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