10 FX Predictions for 2019

Each year James Sinclair, executive chairman and FX veteran, shares his top 10 predictions for foreign exchange. Read this years predictions below:

  1.  Fragmentation will continue – and do so in four dimensions.

Individual venues are fragmenting and offering additional models of trading, such as full amount. They are also experimenting with clearing, enabled by new exchange owners. More FX instruments are being  traded directly rather than by trading their individual legs. In the last Bank of England six monthly survey, spot grew 4%, outrights grew 16.5%, swaps grew 20%, and NDFs grew a whopping 42.5%, admittedly the NDFs were from a lower base.

More funds and other customers are taking short-term risk, not just the higher frequency firms, and more correlation trading across asset classes is taking place as traders have more access to other asset classes. Need to hedge an Aussie position? Trade gold. It’s positively correlated and may have less, or at least delayed, market impact.

  1.  Innovations in credit will expand, both for banks and less creditworthy parties.

Three concepts point to strong prime broking businesses:

  • Firstly, major banks will increasingly borrow other institutions’ balance sheet (why do they need to use their own?)
  • Secondly, we may see smaller banks that have strong credit but do not have active principal trading desks enter prime broking. These banks may be operating cover-and-deal (“riskless principal”) or agency models as their current core businesses.
  • Thirdly, we will see increased tools to serve less creditworthy parties, including through specialised prime of prime offerings targeting such clients. The problem has been that the parties who need credit most, and will pay the most, are in the tail risk.
  1. Emerging markets will become less correlated with each other.

This is a brave prediction. I lived in Asia for 18 years and saw the frustration: trouble in one emerging market (EM) spreads to other emerging markets that, in reality, have little in common. True, many emerging markets have a common theme of dollar-denominated debt, but when investors see trouble in one EM investment in one corner of the world, they often exit all of them indiscriminately. For as long as investors regard “emerging markets” as a single type of investment then contagion is an outsized risk. As investors become more educated and discriminating, contagion will fall and EM currencies will be less correlated with each other. This is good for investors and good for the countries themselves.

  1. The Code of Conduct statements of commitment will reach 1,000.

There are presently over 600 institutions committed (including MarketFactory), listed on the public registers. Recent commitments, and others that we know are in process, are from the buy-side. It is understandable that MiFID II and other compulsory requirements took precedence over a voluntary code such as the FX Global Code of Conduct.

  1.  AI applications will expand focused on supervised learning far more than reinforced learning.  

Artificial Intelligence (AI) applications will continue to expand but will, in reality, take the form of “supervised learning” where a human teacher plays a significant role instructing the algorithm to a large extent rather than fully “reinforced learning” where the algorithm works it all out for itself. A key reason is that the most valuable problems in FX are those that pertain to rare events, and by definition, there are few of them. Human inductive reasoning and instruction for the algorithm are still required. We humans still have our role!

  1. FX volumes will continue to increase.

FX volumes will increase given (i) the likely volatility resulting from Italy, Brexit legislation, Eurozone issues and trade tensions (ii) good availability of credit including through new credit mediums (iii) continuing trend for more funds to hedge actively. I would expect the growth to be consistent with prediction #1 above.

  1. Singapore’s ambitions to have local matching engines will become a reality.

2019 will be the year when Singapore’s ambitions to have local matching engines will be realized. The current paradigm of New York, London and Tokyo dates from 1991 when the predecessor product to EBS was launched in those three locations. Asia looked very different then from now. Singapore’s volumes have equalled or exceeded Japan’s volumes since 2006. More particularly, given the distance of Singapore from other centers and the large number of medium sized institutions in Southeast Asia, both ECNs and market makers are likely to add Singapore as a fourth data center on their networks. Whether most go to SGX or Equinix is still an open question.

  1. Pre-trade risk will become a business necessity.

In U.S. equities it is a regulatory requirement. In FX it is becoming required by fund management. Increasingly it is required by prime brokers. We will soon regard pre-trade risk management in the same way that we wear seatbelts in cars and provide car seats for small children.

  1. The next recession will not begin in 2019, but it will be the length, less the depth, that is concerning when it does arrive.  

I do think we will hear considerably more about the likely impact of the next recession and particularly about its length. The size of the U.S. deficit, especially since the U.S. tax cut, U.S. interest rates that are still at historically low levels (Federal Reserve’s benchmark target is 2.4% compared with 4.25% in December 2007, at the start of the last recession) with limited consequent scope to reduce rates substantially, and the fact that Europe has not addressed its differing north-south fiscal policies augur for a longer but shallower recession than the last one.

  1. We will see viable pilots for T+0 trading

It’s not a new idea. Back in in 1999 there was a an initiative named “Foreign Exchange Differences Settled” (FXDS) that was widely discussed, attracting interest from the various central bank FX committees (see this contemporary paper from New York FXC). I recall it garnered particular support in Japan, as illustrated in this Euromoney article. The focus then was on reducing settlement risk in a pre-CLS world (only the net amounts were to be settled). The reason it did not gain a critical mass of support was the difficulty of moving manual traders from T+2 to T+1. CLS, and other competing solutions at that time, did not require changes to dealer behavior. Today the purpose of moving to T+0 would be faster delivery and, of course, there are far fewer manual traders to move. Already there are signs that this may happen. CLS is launching CLS Now, subject to necessary approvals. California-based startup 9th Gear, which former Royal Bank of Canada FX head, Ed Monaghan, is involved, will attempt to move us T+0 trading.    

We will review these projections, as we did this year, at the six month mark and again at year end. If you would like to speak discuss my predictions or share your own thoughts, please contact me at jsinclair@marketfactory.com