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BAFI3182 - Financial MarketsFX market analysis andTrading strategies reportGroup assignmentLecturer: ​ Nguyen Thanh HaStudents:Nguyen Thi Huong Xuan (s3697326)Trinh Thanh Tung (s3747447)Nguyen Anh Duc (s3747648)Word count: ​ 2498Group Assignment EXECUTIVE SUMMARY Table of Contents INTRODUCTION FX MA...

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BAFI3182 - Financial Markets

FX market analysis and Trading strategies report Group assignment

Lecturer: Nguyen Thanh Ha

Students: Nguyen Thi Huong Xuan

(s3697326)

Trinh Thanh Tung

(s3747447)

Nguyen Anh Duc

(s3747648)

Word count: 2498

School of Business & Management Group Assignment

Table of Contents EXECUTIVE SUMMARY

1

INTRODUCTION

2

FX MARKET PAST BEHAVIOR

3

I. USD/JPY

3

II. AUD/USD

4

DETERMINANTS OF EXCHANGE RATES ANALYSIS

5

I. Relative Inflation Rates

5

II. Relative Interest Rates

9

III. Relative Economic Growth Rates (Real GDP Growth)

14

IV. Official Intervention

18

V. Exchange rate expectations

20

MARKET VIEW

21

TRADING STRATEGY

22

I. Primary objective

22

II. Secondary objective

23

CONCLUSION

24

APPENDICES

24

REFERENCE

27

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School of Business & Management Group Assignment

EXECUTIVE SUMMARY The purpose of this report is to analyze the foreign exchange market and provide beneficial trading strategies for Techcombank.

The paper will examine FX past performances (2017-2019), current and forecast macroeconomic factors that affect the changes of two pairs of currency USD/JPY and AUD/USD, then form a market view in the following 6 months. The report will emphasis on five factors: Relative Inflation Rates, Relative Interest Rates, Relative Economic Growth Rates (Real GDP Growth), Official Intervention, and Exchange rate expectations. The financial and economic data are collected through various credible sources with Thomson Reuters Eikon as the primary. The analysis is complemented with the latest news from numerous academic sources such as Thomson Reuters, Bloomberg, Wall Street Journal, and Financial Times.

Through analysis, we forecast that USD will depreciate against both JPY and AUD in the next 6 months. Therefore, Techcombank should buy JPY and AUD with USD at this moment then sell both currencies to USD by January 2020 to make profits. The estimated profit after trading can be up to 4,564,041.594 USD as if the bank follows the suggested strategies that will be provided in this report.

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School of Business & Management Group Assignment

INTRODUCTION Techcombank is one of the top popular commercial banks in Vietnam in recent years. In the next 6 months, our bank is going to enter the exchange transactions for USD/JPY and AUD/USD. Our objectives are to maximize the profit through trading each pair of currency while remaining the liquidity of the money market and avoid any risks that may happen during the trading period.

This report will be divided into three parts which are: Examination of past behaviors for both USD/JPY and AUD/USD, Analysis of macroeconomics factors that drive the exchange rate, Trading strategies to maximize profit and minimize risks. By performing the tasks, my team will provide the best output that can be archived by the end of trading period.

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School of Business & Management Group Assignment

FX MARKET PAST BEHAVIOR I. USD/JPY

Figure 1: USD/JPY Spot Rate. Reproduced from: Thomson Reuters Eikon.

During the Q4 2017, the exchange rate marked at 112,67 JPY per USD, then slides down to 106,26. According to Sano (2019), under the impact of US-China trade war, investors felt unsafe for their investment in USD, causing USD to depreciate.

Then the USD bid rate rose until the end of 2018. As Vatsal (2019) shown a highlight event is that, US put tariffs on $200 billion of Chinese goods starting January 2019, where many investors’ belief on a safe investment as USD is rampling once more.

Moving to the first half of 2019, the bid rate fall again and stable at around 110 JPY per USD.

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School of Business & Management Group Assignment

This is due to Brexit no-deal is a risk to the future of Japan's automobile industry. (Simon 2019).

II. AUD/USD

Figure 2: AUD/USD FX Spot Rate. Reproduced from: Thomson Reuters Eikon.

In the last 2 years, The AUD/USD spot rate have a tendency to decline, where AUD lost about 15% in value, down from 0,8054 of Q3 2017 to 0,68 in this July. This is because the US-China trade war and the slow global growth have weakened the manufacturing in Australia and hurt the Australia exports, thus leading to less demand for AUD, causing AUD to depreciate against USD (Knaus 2018).

Another key reason is that AUD has become riskier, many investors are now suggested to trade AUD for higher yield currencies, and some started buying their AAA-rated bonds for foreign companies (typically Apple), thus lowering the demand for AUD (Cole 2019).

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School of Business & Management Group Assignment

DETERMINANTS OF EXCHANGE RATES ANALYSIS I. Relative Inflation Rates a. United State ● Historical data

Figure 3: Inflation Rate in the United States. Reproduced from: Thomson Reuters Eikon.

Before June 2018, US had experienced a considerable rise in inflation, reaching a peak of 2.9%. This is mainly because of the rising cost of medical care, shelters and gasoline, which reflects a strong and fully-employed economy (Bartash 2018).

However, due to the significant increase in oil supply, the US gasoline prices started to fall in July 2018 (Constable 2018). Thus, the economy slowed down, causing the US inflation rate to drop rapidly, hitting the lowest point of 1.5% in February 2019. Afterwards, the rate rose modestly for a while then declined again, hitting 1.6% in July 2019.

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School of Business & Management Group Assignment

● Forecast

Figure 4: Forecasted Inflation Rate in the United States. Reproduced from: Thomson Reuters Eikon.

US inflation rate is forecasted to increase gradually in the following 6 months (Reuter). However, many economists have downgraded their inflation projection for Q3 2019 from 1.8% to 1.5%, as “there is a risk that weak inflation will be more persistent than currently anticipate” (Mutikani 2019).

b. Japan ● Historical data

Figure 5: Inflation Rate in Japan. Reproduced from: Thomson Reuters Eikon.

Overall, although the inflation rate in Japan fluctuate continuously throughout the period, the varying range of which is much lower compared to the US. Japan’s CPI has been mostly on the floor, ticking up only during January 2018 and August-October 2018 due to high energy costs (Kuroda 2018).

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School of Business & Management Group Assignment

After October 2018, the rate tailed off again for months, hitting the lowest point of 0.2% (January 2019), which was the result of the US-China trade war discouraging the demand for Japanese electronics, car parts and heavy equipment, thus lowered the prices (White 2019).

● Forecast

Figure 6: Forecasted Inflation Rate in Japan. Reproduced from: Thomson Reuters Eikon .

According to Figure 6, the inflation rate in Japan is expected to slow to 0.5% in Q3 2019, which is similar to forecast from Mari Iwashita (chief market economist at Daiwa Securities) (Kihara & Leussink 2019). The rate then rise again, reaching an even higher rate of 0.8% in Q1 2020.

However, as trade frictions and slowing global growth (due to US-China trade war) threaten to put the brakes on Japan’s economic recovery, other economists argued that inflation in Japan would only decline in the near future (Kihara & Leussink 2019).

c. Australia ● Historical data

Figure 7: Inflation Rate in Australia. Reproduced from: Thomson Reuters Eikon.

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School of Business & Management Group Assignment

Inflation rate in Australia had a generally stable trend at around 1.8-2% throughout most of the period. However, since Q4 2018, the rate has declined significantly, hitting rock bottom of 1.3% in August 2019. According to economists, this is the lowest Australian inflation has been in 50 years, which is mainly due to the massive drop in prices of childcare, vehicles and telecommunications services (Ross 2018).

● Forecast

Figure 8: Forecasted Inflation Rate in Australia. Reproduced from: Thomson Reuters Eikon.

According to Reuter, inflation rate in Australia is forecasted to increase to 1.7% in the next two quarters of 2019, even reaching the 2% inflation target by 2020.

However, many economists argue that nothing might push up Australian inflation in the near future. AMP Capital senior economist Shane Oliver said that not until at least late 2020 would the Australian inflation rate rise (Ross 2018).

----------According to data from Thomson Reuters Eikon, inflation rates of both the US and Japan are forecasted to increase in the next 6 months. As the US’s inflation is higher and could experience a more substantial increase than Japan, prices of US’s goods and services would increase higher in USD term. Therefore: ➔ Less demand for US’s exports, thus less Japanese demand for USD.

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School of Business & Management Group Assignment

➔ More demand for imports of relatively cheaper Japanese goods, thus more supply of USD Thus, USD would fall in value and the currency would depreciate against JPY.

Similar to the analysis above, as the US has higher actual and forecast inflation rates than Australia, USD is expected to depreciate against AUD.

Nevertheless, the precise movement in the value of currencies cannot be determined by inflation rate alone, because not enough information has been provided and PPP theory has to be taken into account.

II. Relative Interest Rates a. United State ● Historical data

Figure 9: Interest rate in the United States. Reproduced from Trading Economics

Interest rate in the US had been increasing gradually from 2017 to January 2019. Afterwards, FED pause it's interest rate rises at 2.5% until July 2019 due to low inflation, US-China trade war and the slowing growth of multiple markets (Europe, China and Japan) (Roubini 2019).

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School of Business & Management Group Assignment

On 31 July 2019, FED lowered the interest rate (to 2.25%) for the first time since 2008. This action aims to stimulate the economy by increasing purchasing power, thus boosting the investment and consumption. However, many economists expect that the rate cut would have limited impact on exchange rates due to the massive quantitative easing and rate cut worldwide (Chadwick 2019).

● Forecast

Figure 10: Forecasted Interest rate in the United States. Reproduced from: Thomson Reuters Eikon.

Interest rate in the US is forecasted to continue declining in the following months due to the unexpectedly persistent low inflation and weak global growth. Many economists expected that the FED would lower borrowing costs at least twice this year (Timiraos 2019).

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b. Japan ● Historical data

Figure 11: Interest rate in Japan. Reproduced from Trading Economics

Bank of Japan (BOJ) has adopted a negative interest rate policy since early 2016 and maintained it at negative 0.1% until the point of writing (August 2019), aiming to encourage borrowing, spending and investment in Japan instead of saving (Farrell 2016).

● Forecast

Figure 12: Forecasted Interest rate in Japan. Reproduced from Thomson Reuters Eikon .

Japan is expected to keep ultra-low interest rates of negative 0.1% for the following 6 months and longer. However, as negative developments in overseas economies and US-China trade

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war raises fears of a global recession, the BOJ has signalled its readiness to ease the situation by changing its interest rate and monetary policies (Kihara & Leussink 2019).

c. Australia ● Historical data

Figure 13: Interest rate in Australia. Reproduced from Trading Economics.

Until June 2019, interest rate in Australia was held steady at 1.5%, marking over two whole years without movement (Williams 2018). However, due to drop in inflation (Figure 7), Australia decided to cut rates to historic low of 1% (July 2019) with an attempt to reduce unemployment and boost inflation back towards its 2-3% target range (Farrer 2019).

● Forecast

Figure 14: Forecasted Interest rate in Australia. Reproduced from: Thomson Reuters Eikon.

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School of Business & Management Group Assignment

Interest rate in Australia is forecasted to remain at 1% for one more quarter then decline to 0.75% from Q4 2019 onward. Many economists expected the rate would not raise until late 2020 due to the weakness in inflation, wages and the uncertainty in consumer spending outlook (Letts 2018).

--------------Interest rate in the US is forecasted to decline in the next 6 months while that of Japan remain stable. However, US’s both actual and forecast interest rates still remain higher than in Japan. ➔ In theory, both foreign and local investors would place their cash excess in interest-bearing instruments (the US) to obtain the higher rate of return. This would increase the demand and reduce the supply of USD, thus USD should appreciate against JPY. ➔ However, US had higher interest rates because it already obtains the higher inflation and inflationary expectations than Japan. Therefore, in reality, USD would depreciate against JPY. This could also due to the current economic instability in the US that makes investors exchange USD to the more stable JPY in order to diminish risks. ➔ Furthermore, Paul Meggyesi (head of FX strategy at J.P. Morgan) forecasts that the FED’s rate cut recently would mostly affect the USD/JPY (weaken the USD), while having limited impact on other exchange rates (Skinner 2019).

With AUD/USD, interest rates in US and Australia are both expected to fall. Similar to the analysis above, US had higher interest rate is due to higher inflation and inflationary expectations than Australia. Thus, USD is expected to depreciate against AUD.

III. Relative Economic Growth Rates (Real GDP Growth) a. United State ● Historical data

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School of Business & Management Group Assignment

Figure 15: Real GDP Growth Rate in The US. Reproduced from: Trading Economics.

Since Donald Trump’s administration in 2016 until now, the US GDP growth has been fluctuating around 2 % on average, except for the unexpected low point of 1.1% in January 2019. Cox (2018) stated streamlined taxes and lessen regulation for the corporate sector is a momentum to US’s growth. This encourages the investment into the US, and widely, more demand for the USD.

● Forecast

Figure 16: Forecasted Real GDP Growth Rate in The US. Reproduced from: Thomson Reuters Eikon

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School of Business & Management Group Assignment

Real GDP Growth Rate in The US is forecasted to decrease in the following months. According to Cox (2019) , the US economic growth would be at a slower pace than last year’s period.

b. Japan ● Historical data

Figure 17: Real GDP Growth Rate in Japan. Reproduced from: Trading Economics.

In the recent 3 years, despite the clumsy Japan having ups and downs, their average GDP growth is steadily around 0,5 %. During 2018, the Japan market has a shock in their GDP gains with a negative point of -0.1% (March 2018) and -0.6% (August 2018).

● Forecast

Figure 18: Forecasted Real GDP Growth Rate in Japan. Reproduced from: Thomson Reuters Eikon

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School of Business & Management Group Assignment

Real GDP Growth Rate in Japan is expected to fall, even hitting a negative point of -0.5% in Q4 2019 (Reuter), indicating that the nation would experience a recession. However, other market participants has provided opposite opinion, forecasting that Japan's GDP would rise in the following months (Trading Economics 2019).

c. Australia ● Historical data

Figure 19: Real GDP Growth Rate in Australia. Reproduced from: Trading Economics .

From January 2017 and its 5 consecutive period, Australia has gained about 0,7 % in GDP growth quarterly. Since then, the country decelerates its growth to below 0,5 %, and it was finally marked at 0,4 % for the Q1 2019. One reason for this constant low GDP growth in Australia is the “per-capita recession 2019” in which people spending on a budget (Karp 2019).

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● Forecast

Figure 20: Forecasted Real GDP Growth Rate in Australia. Reproduced from: Thomson Reuters Eikon

Real GDP Growth Rate in Australia is expected to rise up to 0.7% in the following months according to Reuters.

-----------------------Real GDP Growth Rate in both US and Japan are forecasted to decrease, indicating slow economic growth. However, the rate of Japan is expected to drop to negative, meaning the economy is actually shrinking. Thus, as the expected fall in Real GDP Growth of Japan is much lower compared to the US, there would be: ➔ Less imports, and therefore less supply of the JPY ➔ Decrease the level of overseas investment, and therefore less demand for JPY As both supply and demand of JPY would fall, the net effect of Real GDP growth is difficult to predict the exchange rate in advance

Similar analysis applied for AUD/USD, in which the Real GDP Growth of Australia is forecasted to rise while that of US would fall.

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IV. Official Intervention a. United State ● Historical data

Figure 21: Foreign Exchange Intervention Episodes in the US. Reproduced from: Watts 2019.

US monetary authorities (US Treasury and FED) used to have a long history of intervention (buying or selling its own currency), with aims to: ➔ Reduce excess exchange rate volatility (FX smoothing). ➔ Signal the US’s views on the exchange rate. But due to conflict in rate-setting between the Treasury and Fed, US’s intervention had been out of favor since 1996 and the last intervention was from 2011 (FED of New York n.d.).

● Forecast As Fed’s recent action (lower interest rates) and expected rate-cutting path correspond with the government’s desire, it has been easier for the US to push for FX interventions, aiming to weaken USD to increase exports (Szalay 2019). Various analysts from ING to CIBC also

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School of Business & Management Group Assignment

openly expect intervention from the US shortly (Greifeld 2019). Therefore, it is forecasted that there would be official intervention from the US to depreciate the USD.

If central bank wanted the USD to depreciate from its free market exchange rate, it would enter the market as a seller of USD. This increases the supply for the USD and thus, decrease the value of USD.

b. Japan ● Historical Japan used to consistently depreciate the JPY by selling it heavily before the 2000s (Harding 2018). However, Japan has not taken a market intervention since 20...