Bafi3182 financial markets group 9 team 4 bank 1 _ FX market analysis and trading strategies group report (Week 9) (40%)

This is a 2500word group report focusing on the foreign exchange (FOREX) markets. The FOREX markets are used by entities to both earn a profit from trading, and also to raise funds for international investment projects. As such, for this assessment you will be randomly assigned the role of either a bank, or a corporation with the objective of implementing strategies that will help you achieve the highest possible profit from trading, or raise international finance for investment projects at the lowest possible cost.

BAFI 3182 Financial Markets

FX MARKET ANALYSIS & TRADING STRATEGIES REPORT

Lecturer: Ho Dac Viet Huy

Group: 9

Team: 4 – Bank

Word count: 2640 words

Table of content

I Executive summary 3

II Introduction 3

III Discussions about the market view 4

1 Past FX market behavior 4

1.1 GBP/JPY 4

1.2. GBP/EUR 5

2 A market view forecast 6

2.1 GBP/JPY 6

a Inflation 6

b Interest rate 7

c GDP growth rate 8

d Commodity price 8

e Government intervention 9

2.2 GBP/EUR 9

a Inflation 9

b Interest rate 9

c GDP growth rate 10

d Commodity price 10

e Government intervention 11

IV Trading strategy and performance analysis 11

1 Trading strategy 11

2. Performance analysis 12

V Conclusion 14

VI Reference 15

VII Appendix 20

List of abbreviations

BoE: Bank of England

ECB: European Central Bank

Euro Area: EA

BoJ: Bank of Japan

The report is written by Bank 4 with the purpose of discussing GBP/JPY and GBP/EUR from their past performances by historical events and forecasting the direction it is heading Inflation, GDP growth, interest rates, commodity prices, and government intervention will be used to forecast the behaviors of GBP/JPY and GBP/EUR in the near future Then, we will present our trading strategies and analysis our trading performance Believing that the Pound will strengthen against the Yen and the Euro so our bank’s goal is to keep as much GBP as feasible Finally, we gained A$15,391.72, square one currency (USD), and long £44,447,005 GBP Overall, the trading session provided us with greater experiences for next sessions.

II Introduction

As having a reputation for trading GBP, our bank 4 is a price maker in spot FX for AUD, USD, EUR, GBP and JPY Our primary objective is making profit and square them at the end

of day Regarding the secondary goal, we aim to speculate GBP based on following analysis about past performance within 2 years and future forecast for the next 3-6 months of GBP/JPY and GBP/EUR

This report commenced with research about past behavior and future forecast of GBP/JPY and GBP/EUR, followed by trading strategies and performance evaluation

III Discussions about the market view

1 Past FX market behavior

1.1 GBP/JPY

Figure 1: GBP/JPY exchange rate from 1/2020 to 4/2022 (Macrotrends 2022)

From figure 1, although GBP/JPY collapsed in Q1-2020, the overall and current upward trend highlights a strong appreciation of GBP against JPY

The GBP/JPY plunged by 10% in March and reached the bottom at 129.2754 on 18th

March-2020 due to the first hit of Covid-19 GBP began to decline when the BoE made an emergency interest rate cut to 0.25% to bolster the economy (Inman 2020) Furthermore, this was a reflection of UK economy's unique susceptibility to the worldwide economic disruptions caused by the current pandemic (Ostroff 2020)

In early 2021, GBP/JPY soared as UK economy grew by 7% thanks to vaccine deployment and Brexit trade agreements BoE raised its bond-buying program by $263 billion in November, suggesting an economic improvement (Nagarajan 2020) In Q2/2021, UK witnessed a greater GDP growth rate than Japan (4.8%>0.3%) (OECD 2021) and higher interest rate (0.25%>0.1%) (Trading economics & BoE 2021) Altogether, GBP appreciated against AUD

In 2022, the Pound continued to dig into resistance against Yen GBP rallied to its peak at 167.3549 against JPY The Yen has been dropping recently, as the aftermath of the Russia-Ukraine crisis has wreaked havoc on currency markets, and it has lost about 6% this year,

making it the worst-performing G10 currency (Hongxu 2022) Additionally, the depreciation

of JPY against GBY is because the BoJ’s continue to maintain the extremely loose monetary policy while BoE is intensively tightening its monetary policy stance (McCarthy 2022 & BoE 2022)

1.2. GBP/EUR

Figure 2: GBP/EUR exchange rate from 1/2020 to 4/2022 (ECB 2022)

After peaking at 1.205 in Feb-2020, GBP/EUR reduced to the bottom in March (1.0754) Since 2021, it has gradually increased with the peak at 1.2138 in Mar-2022 indicating the overall appreciation of GBP against EUR

In 2020, GBP/EUR was below 1.16 because Brexit caused uncertain policy expectations in

UK (Coyle 2021) Interest rate declined remarkably to 0.1% (BoE 2022) instigating loss in investment So investment demand decreased and demand of sterling dropped Additionally, the higher inflation rate 0.88%>0.25% (OECD 2022) and lower GDP growth -9.3%<-6.4% (IMF 2022) of UK than Eurozone caused the UK's unstable economic growth Consequently, GBP depreciated against EUR during 2020

Since Q1-2021, GBP/EUR rocketed since the rebounce of UK’s GDP from 91.7% to 96.7% (OECD 2022) owing to Covid-19 vaccination and Brexit trade agreement (Nagarajan 2020)

In the second half, GBP/EUR showed a positive trend because of EUR’s worse performance caused by increasing natural gas price (Watson 2021) It resulted from the supply shortage from Russia and the increasing demand due to low temperature in Eurozone (IEA 2021; Meredith 2021) Besides, 90% of gas consumption is imported indicating EA heavily relies

on natural gas imports (Gunnella 2022) Thus, the notable increase in gas price lowered households’ purchasing power, negatively affected consumption and worsened the Eurozone’s economy (Gunnella 2022) Hence, it weakened EUR In 2021, UK had a greater GDP growth rate (6.9%>5.2%) and interest rate (0.1%>-0.5%) than EA (OECD 2022) Shortly, GBP has appreciated against EUR

2 A market view forecast

2.1 GBP/JPY

a Inflation

Figure 3: UK vs Japan inflation rate forecast (%) from January 2022 to 2023 (IMF 2022) Rising raw material costs, the reversal of the hospitality VAT cut, global supply bottlenecks, skyrocketing energy and tradable goods prices caused by Omicron and Russia-Ukraine have impacted remarkably in inflation of both UK and Japan By Q2-2022, UK’s inflation rate peaked at 8% which is expected to be nearly 7 times higher than Japan’s (1.2%), exposing much more expensive prices in UK rather than Japan (BoE 2022; Fujioka & Ito 2022) Consequently, there will be a decline in the demand for UK exports due to its skyrocketing

commodity prices globally which lessens the demand for using Pound regarding trading partners Furthermore, soaring domestic prices surged UK consumers’ overseas-imported commodities demand because tradable goods are cheaper than local markets’, which in turn bolster imports and raise the supply of the GBP, resulting in GBP demand tightness Thus, GBP is anticipated to depreciate against JPY in next 3-6 months

b Interest rate

Figure 4: UK vs Japan interest rate forecast (%) Jan-2022 - 2023 (BoE 2022, BoJ 2022) Since Mar-2022, BoE decided to push-up its benchmark-funds rate and maintain it at 0.75%

to reserve the economic instability caused by the ongoing inflation (BoE 2022), meanwhile the BoJ remained its monetary policy parameters unchanged with cash rate at -0.1%, until the end of 2023 (Vogado 2022) The higher interest rate would facilitate UK’s capital inflows and discourage outflows due to UK’s higher returns for investors rather than Japan The British residents likely invest larger proportions of their fund to purchase domestic financial assets instead of foreign assets to gain more Hence, this escalates the demand and diminishes the supply of GBP, which results in an appreciation of the GBP against the JPY

c GDP growth rate

Figure 5: UK vs Japan real GDP growth rate (%) from 2021 to 2024 (Statista 2022) From 2022, both UK and Japan are expected to grow slowly as impacted by downside risks stemming from Russia-Ukraine conflict U.K growth is expected at 3.6%, down from 4.4% (January) and slows to 1.1% in 2023, while Japan’s rate is projected at 2.4% in Q2 and 3.2% for overall 2022 (KPMG 2022, IMF 2022) The steep downgrade of UK growth likely reduces investors’ confidence Private investment is debilitated by uncertainty as lingering after-effects of breakdown in Brexit negotiations Consumer spending shrinked due to squeeze on incomes, rising energy and commodity costs, and tax burden (KPMG 2022) UK

is also a net importer from Feb-2022 while Japan escalates their export 14.7% YoY in

Mar-2022 amid continued policy stimulus, the high vaccination rate, and easing global supply constraints inducing Japan be worthier to invest (TradingEconomics n.d), which increased the demand for JPY over GBP, simultaneously, depreciated GBP against JPY in upcoming

3-6 months

d Commodity price

The UK was the largest exporter of platinum worldwide (Garside 2022) Due to the coronavirus and Russia-Ukraine invasion, the global platinum supply chain was disrupted

that led to a steady-rise in platinum prices round 1,021 USD per troy-ounce because of high platinum demand in petroleum refineries, chemical industries, and catalysts production (Statista 2022), thereby strengthen UK’s exports and bolstering the value-of-Pound further Furthermore, Japan is the fifth-largest oil consumer and fourth-largest crude oil importer in the world, hence, it was impacted significantly by global energy costs (Leussink 2022) Skyrocketing energy prices since Feb-2022 contributed to booming Japan’s energy imported prices, which tightened the Yen’s value Hence, the GBP will appreciate against the JPY

e Government intervention

With the purpose of eliminating inflation and achieving a 2% inflation target sustainably at all coming times, BoE decided to modestly tighten monetary policy over the course of 2022 and 2023 (BoE 2022) They decided to maintain an unchanged bank rate of 0.75% to leash inflationary pressure and expect further increases if possible (BoE 2022) Besides, UK increased Money-Supply (M2) to £2993506.00m (~JP¥486474.66bn) at end of 2/2022, while Japan pumped 1183707.90B JPY in March (TradingEconomics n.d.) This indicates that the money supply of Japan is larger than UK's, causing JPY depreciation Hence, GBP appreciated against JPY in further times

Based on forecasts of above macroeconomics factors, GBP is expected to appreciate against JPY in the next 3-6 months.

2.2 GBP/EUR

a Inflation

Due to the remarkable fuel and commodity prices rising caused by the Russia-Ukraine war (Sandercock 2022, Harari et al 2022), both U.K and Eurozone suffered serious impacts from inflation booming U.K’s inflation is anticipated to peak at 8% in the Q2-2022 before declining gradually (Glass 2022), meanwhile, Eurozone inflation reached an all-time high of 7.5% (Liboreiro 2022) The inflation is predicted at the rate of 7.3%, 6.9% and 5.8% for the Q2, Q3 and Q4 respectively (Nair 2022) The inflation rate in UK exceeds that of the Eurozone, making UK products and services more costly This might result in a decrease in

UK exports but an increase in Eurozone imports Hence, GBP is projected to depreciate against EUR during the next 3-6 months

b Interest rate

In response to soaring inflation, BoE hiked interest rates back to the pre-pandemic level of 0.75%, with projections that further increases can be predicted throughout 2022 (The Times 2022) Whilst, despite historic inflationary pressures, ECB has maintained interest rates steady since they anticipate that inflation will continue to remain elevated for longer than originally anticipated, but will begin to drop this year The central bank's benchmark refinancing rate will continue at 0% for the remainder of 2022, while the rate on its deposit facility will remain at -0.5% (Amaro 2022) With an increased interest rate for the upcoming 3-6 months, UK tends to attract more foreign investors; also, British investors are expected to invest domestically, increasing demand for and the value of GBP compared to EUR

c GDP growth rate

Although UK has few direct economic links to Russia, it is exposed to global energy prices (Glass 2022) Due to rising inflation, increasing tax and global shocks, BCC reduces its forecast for UK’s GDP growth in 2022 to 3.6%, which stagnates at 0.2% in Q2 and 0.1% in Q3, compared to a 0.7% slow in Q1 of this year (BCC 2022) The economy is projected to recover since the slow rate is beginning to diminish quarter-on-quarter Meanwhile, EA has been comprehensively impacted by its reliance on Russia for supply After Ukraine crisis weighed on the economy, particularly Germany and Italy, IMF cut the eurozone's growth projections for 2022 to 2.8% (TRTWorld 2022) These two of Europe's largest economies are expected to experience negative growth in mid-2022 (IMF 2022), implying that the Eurozone's growth would be inadequate Therefore, for the next 3-6 months, UK's economy

is more compelling to invest than EA, appreciating GBP against EUR

d Commodity price

As previously stated, UK has benefited from platinum exports due to increased demand induced by a scarcity of supply Platinum is used to convert exhaust from automobile engines into less hazardous waste products (RSC n.d.) Nevertheless, the war in Ukraine-Russia has disrupted the flow of platinum which will cause the price explosion, severe supply shortage

in the months to come constitutes a strategic threat to EA, since EU is well-known for its extensive vehicle manufacturing industry, implying imported platinum (Gehrke 2022) Furthermore, EU is largely dependent on Russia in terms of oil, thus, finding a substitution supplier is the EU's priority lately, however, it would take time for that adjustment, indicating

for the next 3-6 months, EU is not an ideal investment (CBS News 2022) Thus, the price rise

in exporting platinum gives GBP more appreciation than EUR

e Government intervention

To alleviate the detrimental effect of prices caused by the ongoing war in Ukraine, UK government set out a package of support measures totalling £11 billion to assist people with rising energy costs, as well as a £6 billion increase in the National Insurance contribution threshold this year (KPMG 2022) However, this is just temporary countermeasures until UK finds other suppliers Given this context, ECB takes a wait-and-see approach ECB council members argue that the Eurozone's problems are driven by external supply shocks, not by any element that the ECB can control (CNBC 2022) Therefore, the currencies of both economies' appreciation is ambiguous

In conclusion, GBP is predicted to appreciate against EUR in the next 3-6 months due to increased interest rates and GDP growth rate and the benefits of platinum exports

IV Trading strategy and performance analysis

1 Trading strategy

For the primary goal, profits are maximised by the difference between buying and selling foreign currency while squaring all currency positions We plan to make a wider bid-ask spread than the standard quote that cannot attract price-takers but achieving higher yield So, raising the ask rate/lowering the bid rate by 3-5 pips is moderate Each team has two-person, one will take the real quote from Investing.com and record transactions while other will modify quotes and communicate Moreover, in previous practice sessions, we easily choose the final rate wrong So we create an automatic function to ensure its accuracy We just need

to provide if we are maker (M) or taker (T), if we sell (S) or buy (B) and the bid and ask, Excel will give us the right final rate