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BAFI 3182 – Group 3 – Team 5

The FX Market Analysis & Trading Lecturer: Truong Mai

Group members:  Bui Huynh Duc – s3651394  Tu Thi Yen Nhi - s3594251  Pham Phuong Linh – s3578688 Table of Contents Executive Summary:...........................................................................2

BAFI 3182 - Team 5 - FX Report

A.

Introduction:................................................................................3

B.

Market View & Analysis:...............................................................3

I.

Currency pairs:................................................................................................................................................3 1.

USD/HKD...................................................................................................................................................3

2.

GBP/HKD....................................................................................................................................................5

3.

GBP/USD....................................................................................................................................................6

II.

GDP Growth Rates:.........................................................................................................................................8 1.

United States.............................................................................................................................................8

2.

United Kingdom.......................................................................................................................................10

3.

Hong Kong...............................................................................................................................................11

III.

Inflation rate:................................................................................................................................................13 1.

United States...........................................................................................................................................13

2.

United Kingdom.......................................................................................................................................14

3.

Hong Kong...............................................................................................................................................15

IV.

Interest rate:.................................................................................................................................................17 1.

United States...........................................................................................................................................17

2.

United Kingdom.......................................................................................................................................18

3.

Hong Kong...............................................................................................................................................20

V.

Government Intervention:............................................................................................................................21 1.

United States...........................................................................................................................................21

2.

United Kingdom.......................................................................................................................................21

3.

Hong Kong...............................................................................................................................................21

VI.

Commodities:...............................................................................................................................................22

C.

Market Summary........................................................................23

D. Trading:.....................................................................................24 I.

Trading Strategy:...........................................................................................................................................24

II.

Risk Assessment:..........................................................................................................................................25 a.

Transaction risk.......................................................................................................................................25

b.

Liquidity...................................................................................................................................................26

c.

Interest rate risk......................................................................................................................................26

E.

Conclusion:................................................................................26

F.

Reference List:...........................................................................27

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BAFI 3182 - Team 5 - FX Report

Executive Summary: This report is written by the Foreign Exchange Department of Sacombank to propose a trading strategy that would bring profit to the bank. The historical data of factors that have impacts on the three currency pairs (USD/HKD, GBP/HKD and GBP/USD) are analyzed in order to make predictions on the exchange rates in the next 6 months. Those factors which are investigated in this report are the GDP annual growth rate, inflation rate, interest rate, changes in prices of commodities and government interventions.

It is concluded that since the value of USD appreciates against GBP and HKD is predicted to enhance its value compared to the currency of US and UK in the next 6 month. Therefore, the trading strategy is that Sacombank should buy HKD now by trading with both USD and GBP. After that, the bank will sell HKD back to GBP when HKD become more valuable in effort to earn the maximum returns.

Besides that, the following risks should be considered liquidity, transactions risks and interest rate risks so as to maximize profits and minimum losses during the trading period

3

BAFI 3182 - Team 5 - FX Report

A. Introduction: Sacombank was established in 1991. It is considered as the joint stock commercial bank with the largest charter capital and branches network in Vietnam.

The purpose of this report is to analyze macroeconomics factors that would affect USD/HKD, GBP/HKD and GBP/USD currency exchange rates. Then, forecasts of future exchange rates will be made so that Sacombank can base on that to come up with the most profitable trading strategy.

This report is consisted of two main parts. The first part is data analysis. The second part is the detailed trading strategy for profit maximization.

B. Market View & Analysis: I.

Currency pairs: 1. USD/HKD

From 2013 to 2015, the USD/HKD exchange rate had a steady trend. In 2016, it increased dramatically from 7.7514 to 7.7967, indicating that USD was appreciated against HKD at this point of time. The reason for this was because the Federal Reserve System (central bank of US) decided to increase interest rate after a decade (Djanga 2016). By December of 2016, the exchange rate plummeted and reached a steady rate, which was averagely at 7.7584 4

BAFI 3182 - Team 5 - FX Report

before entering an increasing period from February 2017 until it peaked at 7.8249 in September 2017.

USD/HKD exchange rate increases from January 2017 to today [figure 2]. Although it decreased slightly in September 2017, it still has a sign to increase again in the upcoming period. The reason behind may be because of the Pound’s plummets. After Brexit, investors have switched from saving in GBP to USD to protect them from losses, resulting in an appreciation of the USD (Lawrence 2017).

The exchange rate of USD/HKD is estimated to decrease to 7.8171 and the figure continuously falls to 7.8000 [Table 1]. It can be seen that the value of USD will be predicted to depreciated against HKD. Lee (2017) estimates that Hong Kong economy tends to grow at fastest in 6 years and this causes the appreciation of Hong Kong currency. Moreover, due to the action of Fed, the increase in interest rate causes the dropping of GDP growth in the US in the future which may lead to the depreciation of USD.

5

BAFI 3182 - Team 5 - FX Report

2. GBP/HKD

From July 2014 onwards, GBP/HKD exchange rate experienced a decreasing trend and reached the lowest point of only 9.44 in the first quarter of 2017. The reason for this depreciation in the British pound was because of the confirmation of the Brexit vote. Due to the uncertainty in UK politics, economy and financial sector, UK became less attractive to investors, resulting in less demand for GBP. As a result, GBP depreciated.

Since the end of 2016 till now, there is a sign of British Pound recovery [Figure 4]. Although there are still ups and downs, the overall trend is upwards. The reason for this upward sloping is because Britain and the European Union have moved closer to a Brexit negotiation

6

BAFI 3182 - Team 5 - FX Report

deal that would pave a way to future trade pact, meaning that British market would be more stable in the future (Chatterjee 2017).

The exchange rate GBP/HKD is forecasted to decline to 10.3087 and 10.1400 in the next six months due to the effect the Brexit vote (Hickey 2017) [Table 2]. This estimates that the value of GBP is continuously depreciated compared to HKD. 3. GBP/USD

Comparing figure 5 to figure 3 above, it is clear to see that the changes in GBP/USD and GBP/HKD have similar patterns. This reflects the negative impact of Brexit votes to British Pounds, weakening it compared to other currencies. The GBP/USD exchange rate also hit the lowest point during the first quarter of 2017 (i.e. 1.2167).

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BAFI 3182 - Team 5 - FX Report

Due to the positive impact of the Brexit negotiation deal with the EU as mentioned above, the GBP is in recovery. Figure 6 shows the GBP/USD exchange rate from the January 2017 to now. It shows that GBP is strengthened. It has increased from the lowest point at 1.2167 to 1.8862 on the 29th of November 2017.

The GBP/USD exchange rate is expected to decrease in the next 6 months. This means that regardless of the UK government’s efforts in stabilizing UK economy, the growth of GBP is still viewed as uncertain. In the near future, investors still prefer using USD instead of GBP in order to avoid currency risks. This leads to the continuous appreciation of USD against GBP despite the recovery of GBP.

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BAFI 3182 - Team 5 - FX Report

II.

GDP Growth Rates: 1. United States

GDP Annual Growth Rate of US from 2012 to 2016 fluctuated between 2.22% and 1.62%, indicating a healthy economy (Amadeo 2017). The sharp decrease from 2.60% to 1.62% in 2016 was because the appreciation in USD in 2016 slowed exports as it made American goods more expensive compared to the goods from other countries. Therefore, a decrease in exports (X) would lead to a decrease in GDP.

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BAFI 3182 - Team 5 - FX Report

In Q3 2017 the growth rate of US was strong at 3% [Figure 8]. That is because the extra spending is needed to repair damages caused by the recent hurricanes. Moreover, business spending and investment have increased as the US withdrew from the Paris Agreement. Since the growth is healthy and strong, the Federal Reserve is expected to increase interest rates during Q4 2017 and several times in 2018 in order to increase government budget (Panye 2017). The increase in interest rate will strengthen USD due to more capital inflows.

10

BAFI 3182 - Team 5 - FX Report

2. United Kingdom

The GDP annual growth rate of UK peaked in 2014 at 3.07% which was the fastest growth rate in nine years. The reasons behind were because of increases in production, services, consumer spending as well as strong performance of exports. After that, the growth rate was slower due to Brexit’s influence. That is because of slow employment, salary growth and pessimistic about the economy, leading to a decline in consumer spending and investment (Allen 2017). Besides that, this might influence the exchange rate of GBP with other currencies due to the significant fall in the GDP growth rate in recent years.

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BAFI 3182 - Team 5 - FX Report

The massive depreciation of GBP leads to higher import prices. This makes necessary goods such as food and fuel more expensive. This puts more pressure on households, decreasing consumer spending even more. Therefore, since the GDP growth rate is expected to be low at 0.3-0.4% per quarter in the next two years, slow development in UK’s economy acts a

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BAFI 3182 - Team 5 - FX Report

deterrent for GBP to thrive against with other currencies, expecting GBP keep depreciating n

the future. 3. Hong Kong

13

BAFI 3182 - Team 5 - FX Report

The figure above displays the healthy GDP annual growth rate of Hong Kong from 2012 to 2016. There was a big increase from 1.70% in 2012 to 3.10% in 2013. The key driving forces for this growth were due to increases in domestic demand and exports of services (Hong Kong Government 2013).

The GDP annual growth of Hong Kong is expected to continue staying positive and healthy with a slight decrease from 2.9% in Q2 2017 to 1.5% in Q4 2017. The reason for the decrease was because of the seasonal unemployment rate was about 3% (Fung 2017). However, it is likely to rise up again, reaching the steady growth of 2.7% in the following quarters due to lower inflation and higher Hong Kong’s merchandise exports. These are also the reasons why HKD is expected to rise.

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BAFI 3182 - Team 5 - FX Report

III.

Inflation rate: 1. United States

In January 2015, the inflation rate was below 0% (around -0.1%) due to the lower prices of gasoline, crude oil and commodities (Patton 2015). This means that the US had to face the deflation and the decrease in import cost because of the exchange rate. Moreover, the trend was fluctuant increasing to 2% in September 2017. High inflation illustrates that the demand for import will increase at expense of the export, which leads to the rising in supply of USD and the decrease in demand of USD. However, it can be seen that USD appreciated against HKD and GBP. Thus, given the changes of the inflation rate, the exchange rate of the country will not be affected.

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BAFI 3182 - Team 5 - FX Report

In 2018, Thomson Reuters estimates that the inflation rate of US will slightly fluctuate around the ideal inflation rate (2%), suggesting that the exchange rate of US will not be impacted by inflation.

2. United Kingdom

In July 2015, UK coped with the lowest inflation level for the half century with the significant dropping to around 0% due to the decrease in oil and petrol prices (Cadman 2016). For the next period, the trend tended to increase sharply to 3% in 2017 due to the increase in costs of oil (Jackson, 2017) and the impacts of Brexit, which caused the significant increase in 16

BAFI 3182 - Team 5 - FX Report

living costs and the price of domestic products in UK. Thus, British people tended to consume more foreign products, which led to the depreciation of GBP against other currencies.

Thomson Reuters (2017) predicts that the inflation rate of UK will decrease slightly from 2.7% in 1st quarter to 2.5% in 3rd 2018. This suggests that the value of Pound will slightly increase which leads to the low cost of imports and hampering exports. 3. Hong Kong

Overall, the inflation rate of Hong Kong decreased significantly by 2.51% between 2015 and 2017. Specifically, the trend fell sharply from 4.06% in 2015 to 1.27% in January 2017 and recovered back to 1.55% in September 2017. 17

BAFI 3182 - Team 5 - FX Report

The low inflation will allow the increase in demand for exports goods and the falling of import demand. This results in the appreciation of HKD.

The inflation rate is estimated to decrease between 2.2% in the 1st quarter and 1.9% in 2nd quarter 2018 (Figure 18). It can be illustrated that the number of import goods will decrease when the price of domestic products is cheaper and this leads to the appreciation of HKD.

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BAFI 3182 - Team 5 - FX Report

IV.

Interest rate: United States

The trend increased slightly from 0.125% in October 2015 to 0.375% in December 2015 and this figure remained stable until the end of the year 2016. Moreover, in the next 6 months, the rate rose to 1.125% and this number was constant until December 2017. Overall, between 2015 and 2017, the real interest rate of US increased significantly. Therefore, since the real interest rate continues to grow over period, US will experience the increase in capital inflows and the decline of capital outflow, allowing the value of USD enhance greatly.

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BAFI 3182 - Team 5 - FX Report

Thomson Reuters (2017) estimates that the real interest rate will increase from 1.25% in Q1/2018 to 1.75% at the end of the year. This trend encourages and attracts more capital inflow, accompanied by the higher demand of USD. As a result, the value of USD will become appreciated in the future.

1. United Kingdom

The interest rate decreased from 0.5% in 2015 to 0.25% in 2016. Due to the influence of the EU referendum vote (Allen & Elliott 2016). This means the costs of borrowing would be 20

BAFI 3182 - Team 5 - FX Report

cheaper, which encouraged capital outflow and thus the supply of the GBP increased. However, the low interest rate would act as a deterrent for foreign investors investing in the UK because of the low profits and returns. Hence, this leads to the depreciation of the GBP. Although the interest rate has increased to 0.5% in the third quarter of 2017, this number is still considered as the less attractive rate for enhancing more capital inflow.

Thomson Reuters (2017) estimates that the official bank rate is constant at 0.5% until the third quarter in 2018. In fact, GBP is predicted to depreciate against USD and HKD. Thus, the interest rate will not affect this currency.

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BAFI 3182 - Team 5 - FX Report

2. Hong Kong

Overall, the interest rate increased slightly from 0.5% in 2014 to 1.5% in July 2017 for the purpose of tightening borrowing rules of Commercial banks in Hong Kong (John 2017). This figure remained stable until October 2017. With high interest rate, Hong Kong would be a great attractive deal for foreign investment, which allowed the increase in the demand of Hong Kong’s currency. This means that HKD will be enhanced its value.

It can be predicted that the bank rate will be constant at 1.75% during the period from Q4/2017 to Q3/2018....