FX Global Code of Conduct

| 09-06-2016 | Simon Knappstein |

 

Last month the BIS published the first phase of the FX Global Code. The final version is planned for completion by May 2017. What is this Global Code and what is the BIS trying to achieve by the establishment of this Code?



Recent history

In the wake of the Libor Scandal a similar rate rigging scandal emerged in the FX market. This related to fraudulent actions around the fixing process of FX Benchmarks. In 2013 the Financial Stability Board commissioned a working group to firstly analyse the structure of the FX Market and the incentives that might promote inappropriate trading activity around a benchmark fixing, and then come up with some potential remedies to address the problems found.

In September 2014 a report was published by the FSB containing 15 recommendations to reform the FX Benchmark process. A number of these recommendations concerned market conduct, specifically related to the fixing process.  To further restore trust in the foreign exchange market and make this market function as effectively and efficiently as possible the BIS commissioned a working group to facilitate the establishment of a single global code of conduct for the FX Market and to come up with mechanisms to promote greater adherence to the code. The first phase of this global code is now published and I will share some observations with you.

What is the Global Code?

The Global Code is a set of global principles, not rules as rules are easier to arbitrage than principles. It is meant to provide a common set of guidelines to promote the integrity and effective functioning of the wholesale FX Market, i.e. a robust, fair, liquid, open, and appropriately transparent market

Unlike for instance the Model Code by the ACI Forex, which is only intended for the sell side and more rule based, this Global Code is developed by a partnership between Central Banks and Market Participants from both sell- and buy-side globally.

The Global Code is organised around six leading principles:

·      Ethics

·      Governance

·      Information Sharing

·      Execution

·      Risk Management and Compliance

·      Confirmation and Settlement Processes

Furthermore it is emphasized that this Global Code does not supplant the applicable laws and regulations for the relevant jurisdictions. It should serve as a reference when conducting business in the FX Market.

So far, so good.

The good thing in this Global Code is that it applies to all organisations and persons active in the wholesale FX Market globally and thus creates a level playing field. The more cynical observer could argue that codes of conduct are around for decades and that these have not been very successful in preventing scandals.

Obviously, thinking of myself as an ethical and honest ex-salesperson and trader, most of these principles are a no-brainer. There is only one principle and related good practices that leaves me a bit puzzled, and that concerns Execution, sub-principle 5: The Mark Up applied to Client transactions by Market Participants acting as Principal should be fair and reasonable. Sounds fair enough, but in a competitive world with Clients comparing quoted prices and trading the most advantageous price to them, hasn’t mark-up already ceased to exist? So what is fair and reasonable about zero mark-up? Or shouldn’t Clients trade the most advantageous?

I wonder, dear reader, what your thoughts are on this?

Reference:
Speech by Mr Guy Debelle, Assistant Governor (Financial Markets) of the Reserve Bank of Australia, at the FX Week Europe conference, London, 25 November 2015.
FX Global Code: May 2016 update

 

Simon Knappstein - editor treasuryXL

 

Simon Knappstein

Owner of FX Prospect

EUR/USD Outlook

18-05-2016 | by Simon Knappstein |

 businesspaper

The US Dollar is currently going through a soft spell. Most markedly against EM, but also against the EUR. Upside seems contained so far by the very easy monetary policy of the ECB. The question is if we are witnessing simply an extension of the ranging price movement as seen in the last 5 quarters or whether this is the start of a lasting recovery?

 

 

FX Prospects consensus forecast for EUR/USD is 1.1020 in 3 months and 1.0810 in 12 months.

outlook eur/usd

Let’s take a closer look at the arguments that argue for a higher EUR/USD than consensus.
Danske Bank is in the longer term the most bullish, forecasting a shallow move lower to 1.12 in 3 months and a subsequent move higher to 1.18 in 12 months.
Nordea is looking for a move to 1.16 in 3 months only to see the pair fall thereafter to 1.05 in 12 months.

Danske is expecting for relative rates to play a more important role in the near term where the ECB will be challenged once again on its mandate by market inflation expectations and the Fed might turn out a bit more upbeat on a September rate hike. This, coupled with a Brexit risk premium weighing on the EUR as well, should lead to some downside in the next 2 or 3 months. Further out, they expect valuation to drive the EUR/USD higher to 1.18.

Nordea on the other hand, sees the EUR strengthening in the near term on a combination of a diminished likelihood of deeply negative rates by the ECB, potential risk aversion that leads to some EUR short covering and a dovish shift in the Fed’s reaction function. Further out then, as this dovish shift is reflecting an undue focus on domestic- and global risks (Brexit, China) that do not materialise, a hawkish re-pricing of the curve will support the USD at the same time that increasing inflation in the EZ is lowering real rates and leading to EUR-negative portfolio outflows. Bringing EUR/USD to the aforementioned level at 1.05 in 12 months.

These are two very different views on where EUR/USD is heading. It is not though, a matter of who is wrong and who is right. Opposing opinions help you make up your own mind and improve on your investment decisions.

 

Simon Knappstein - editor treasuryXL

 

Simon Knappstein

Owner of FX Prospect

 

 

 

Rousseff impeachment: short-term strength for BRL

brasil22-04-2016 | by Simon Knappstein |

Will the ousting of President Rousseff help the Brazilian Real to strengthen or not?

From a high of 4,15 at the end of January USD/BRL has fallen steadily to 3,55 level today. This strengthening came on the back of a broadly weaker USD, a rebounding oil price, renewed inflow into Emerging Markets in general and supported by a high carry for the BRL more specifically.

 

What has played an important role more recently is the diminishing popularity of president Dilma Rousseff. This comes in part by a massive corruption scandal at state-run oil company Petrobras with a lot of Worker’s Party politicians already convicted. Yesterday, the Brazilian Lower House voted for her impeachment over allegations for manipulating government accounts to hide a budget shortfall. All this has crippled the government’s ability to deal with an economic recession and rising unemployment.

The consensus FX forecast for USD/BRL, with current spot at 3.62, is 3.90 in 12 months’ time.

Consensus FX forecast for USDBRL

According to Nordea the potential impeachment of president Rousseff is a “short-term positive for the BRL at best. Short-term positive because markets seem to cheer the potential for change and for more political stability under Vice President Temer, albeit with the recognition that the BRL has already strengthened a lot and that most of the impeachment may be priced. More importantly, however, Brazil’s huge and numerous challenges will not go away with President Rousseff and markets may soon realize that.”

ING that expects USD/BRL to trade at 4.05 in one year’s time states: “Yet, we continue to see a high risk of the current market euphoria to fade as an impeachment does not necessary mean a highly stable political environment thereafter”. That might be an understatement as vice-president Temer, who would assume power on an interim basis when Rousseff has to step aside, also runs the risk of an impeachment process.

And although, as Scotiabank poses it “hopes that changes in the country’s leadership could lead to more market friendly economic policies” market participants seem to underestimate that “Brazil is undergoing a deep economic crisis exacerbated by a profound crack in its political institutions” and more specifically underestimate “the nature of the structural change required to rebuild credible political institutions”. Scotia sees the BRL weakening to 4.20 in 11 months’ time.

So in the short-term the BRL might strengthen a bit further still but further out it is still in general expected to weaken to around 4.0 against the USD.

Simon Knappstein - editor treasuryXL

 

Simon Knappstein

Owner of FX Prospect

Negative Interest Rate Policy: No lasting effect on FX

14-04-2016 | by Simon Knappstein |

bank

 

Negative interest rates are gripping Central Banks worldwide. The BoJ has resorted to this unexpected and unusual policy at the end of January. The ECB is expected to dig deeper into negative realms at their March meeting. The Swedish Riksbank has also gone negative and the Fed is contemplating the possibility for the eventuality economic growth will falter and inflation will fall. And of course the Swiss are already quite accustomed to negative interest rates. But in the FX markets the effects are minimal and short-lived.

So, are Central banks reaching the end of the effectiveness of their extremely loose monetary policies? If so, the big question is what next? Plain currency intervention? Hard to imagine currently, though the Swiss National Bank is said to be continuously intervening to prop up EUR/CHF.

The ECB has crossed the zero interest rate border in the summer of 2014 bringing its depo-rate to minus 0.10%. A move intended to stimulate credit growth by commercial banks, and as a means to lower the value of the Euro as to import more inflation. Although the latter was not explicitly mentioned everyone knows it was.

Since then the Swiss National Bank in December 2014, the Riksbank in February 2015 and the Bank of Japan in January 2016 have followed suit by introducing negative interest rates.

Currency impact

Interest rates
Figure 1 – Currency impact

The impact on the currency exchange rate is questionable and certainly not a straightforward main driver, as can be seen in figure 1.
When the ECB introduced a negative interest rate in the summer of 2014 it was accompanied by the start of the QE program and indeed EUR/USD moved considerably lower. The rate cut to -0.3% last December had no material impact on the exchange rate, even though it was followed by the first Fed rate hike in years.

The pressure on EUR/CHF could not be relieved by a rate cut to -0.25% in December 2014 so it was soon followed by the abandoning of the minimum exchange rate at 1.20 and a further cut to -0.75%. EUR/CHF stabilized but only continuous intervention by the SNB has brought the pair higher since then. The charts for EUR/SEK and USD/JPY speak for itself.

The conclusion is that there is very little to no evidence that negative interest rates lead to weaker currencies to support inflationary pressures.

Simon Knappstein - editor treasuryXL

 

 

Simon Knappstein

Owner of FX Prospect

 

Consensus FX forecasts March 2016

30-03-2016 | by Simon Knappstein |

FX forecast

 

The March edition of the consensus FX forecasts report shows that spot US Dollar has weakened broadly since February. In the forecasts for 1 year the changes for he USD are less strong and more diverse though.  



Changes vs. February

Against the CAD and RUB the USD is expected to weaken a little more than last month. The oil price is a main driver here. Less strengthening is seen in 1 year against the Indonesian Rupiah IDR and against the South African Rand ZAR. Both are supported by a high carry, and in the case of the IDR coordinated action in the form of economic reforms and interest rate cuts is supporting economic growth and the Rupiah.
Against the general direction of a weakening USD there are a few currencies against which the USD is expected to strengthen more versus last month. These are the Indian Rupee INR, the Turkish Lira TRY and the Korean Won KRW. For the specifics here please see the comments in the report.

Market Focus

Developed Markets

Although the Fed has voiced a softer tone on the interest rate path, the USD is still expected to strengthen supported by tighter monetary policy from the Federal

Reserve this year. A hawkish re-pricing of the 2016 path presents upside risk to the USD.
Expect the EUR to weaken on the basis of policy divergence and interest rate differentials.
The Brexit threat has provided for a sizeable drop in GBP; risks remain tilted to the downside into the June 23 referendum.
The recovery in oil prices is still fragile and a pullback would punish the CAD. Over the longer term, the CAD should take flight anew more sustainably, in step with the oil price recovery and the improved economic environment in Canada.
JPY is expected to weaken, as it reverses its YTD sentiment-driven gains and monetary policy divergence takes the upper hand again.

AUD sentiment might be tentatively turning the corner, but AUD remains vulnerable to a slowing Chinese economy.

Emerging Markets

The RUB stabilised on the back of a rising oil price, but the recovery is fragile and tentative.
TRY found some support during the recent risk-on period but idiosyncratic risks and on-going geopolitical risks are expected to weigh on the TRY.

Latam

The BRL has recovered somewhat thanks to a combination of high yields and a more benign global risk environment. Political risk remains high and unwinding of the carry trade might see a sharp weakening of the BRL.
MXN has responded positively to aggressive and concerted policy action. Further gains in MXN are expected.

Asia

CNY should weaken modestly in response to slower growth and central bank policy accommodation.
IDR is supported by a change in investor sentiment on the back of coordinated action by the central bank and government.
Simon Knappstein - editor treasuryXL

 

Simon Knappstein

Owner of FX Prospect