March 18, 2022
[00:03:12] How big is the FX market and how does it compare in size with other markets, for say equities or bonds?
[00:05:33] Currencies are in constant flux. What determines these movements?
[00:13:16] If we unpick the demand side first, what are the key economic data that affect FX movements?
[00:16:10] Who are the currency speculators and what role do they play? Do they make the market more efficient or distort it?
[00:19:14] What advice do you give exporting and importing SMEs when it comes to navigating FX markets?
[00:23:53] FxPlew’s Market Brief
Ben: [00:00:00] Welcome to Talking Edge. This is a new series of live conversations that we’re going to be hosting fortnightly, where we’re going to be discussing FX markets and FX strategy. I’m delighted to introduce our speakers for today: we’ve got Barry McCarthy, who’s CEO of Assure Hedge. He’s going to be our host for these series of Talking Edge.
Our guest for this first episode is Paul Plewman, who is Chief Operating Officer at Currency Transfer- the global payments network. If you don’t know it already, you need to check out Paul’s daily market brief, where his alter-ego, FX Plew, delivers a brief summary of current affairs and market news while (get this) riding on an air wheel, which is quite a feat! If you haven’t seen it, it’s something you should check out.
I’m going to pass it over to Barry in a second to put the questions to Paul, but on today’s show we’ll be discussing the basics of the FX market, in particular the size of the market, the factors that drive supply and demand, the key economic data that people should watch out for, and the role of speculators and more.
The only thing before I pass over to Barry is to say, this is an interactive session. As you’ll see on the Zoom here, you’ve got the option to ask questions, you’ve got the options to contribute to the chats. Please do. The benefit of attending this live is that it’s an interactive session. If you happen to miss it, it’s also put out as a podcast and a video on YouTube, so you can catch it, or if you want you can watch it for a second time.
I’m going to pass it over to Barry. My role is done. I’ll just interrupt if there are questions that Barry misses or chats that need to be responded to by the speaker. Over to you, Barry.
Barry: [00:02:01] Thanks, Ben. Everyone, welcome to our very first additional Talking Hedging. It’s a real honor for me to welcome Paul Plewman here today. As Ben mentioned, he’s a market veteran. He’s currently COO of Currency Transfer, and I know him quite well from his daily market brief as well. I watch that all the time. If you’re not a subscriber, you should definitely sign up, because it’s really informative and entertaining to watch at the same time.
Paul you’re very welcome. I’ll just start off. We’re going to try and keep this simple. There’s a lot of jargon in FX. Even at the word FX itself is jargon – it stands for foreign exchange (FX). I think I’m going to put this off to a good start by keeping it simple.
Paul, just to kick off, give us a sense of how big the currency market is globally. Just to allow people listening in to get a sense of the size of it, could you maybe compare it to other markets or give it some sort of context in that way? That’d be great.
How big is the FX market and how does it compare in size with other markets, for say equities or bonds?
Paul: [00:03:12] Yeah, sure. It’s often overlooked, the size of the FX market. Headlines in the news may quotes an exchange rate, but the main focus is often on the stock markets. To put things in comparison, stock markets, I think in both New York and London may do about 1 trillion dollars’ worth of trade every day, which obviously is a lot. But it’s absolutely dwarfed by the foreign exchange transactions, where the daily average is close to 7 trillion. I think it is about $6.8 trillion traded every day in foreign exchange. There’s an awful lot more volume going through the FX market than any other market out there.
Barry: [00:03:54] Which participants are driving that volume? Can you give us a sense of where that value is coming from?
Paul: [00:03:59] That’s part of the breadth. It could be anything from you or me having an individual punch through a contract for difference, or even just buying your holiday money as in when the borders open and we can jet off to Portugal once again.
But it goes through the tier where you’ve got big business, you’ve got big banks trading the money, and then of course you’ve got governments who are manipulating the supply and the value of their currency to serve their own economic goals.
Barry: [00:04:36] Okay. Everyone who lives in this world is affected by currencies to some degree, right? We’re constantly seeing big movements in major currencies. Even in the last 12 months, we’ve seen 10, 15% moves in some of the major currency pairs. What are the main things that causes those movements to happen?
Paul: [00:05:03] You can drill it down behind all the other general drivers. It comes back to that famous university lecture of mine, Econ 101 – basically it’s driven by the economics of supply and demand. More demand for any individual currency, just like any other asset class, will drive the price up. Really then you need to look at what drives the demand, and that’s probably another podcast in its own right diving into that kind of detail.
Currencies are in constant flux. What determines these movements?
Barry: [00:05:33] I should have paid attention there in hindsight, to Econ 101 myself! Anyway, let’s talk a little bit about inflation. Can you explain what inflation is and how that affects the movement of currencies?
Paul: [00:05:48] Well, inflation broadly is the increase in prices from one year to the next. How much more do you have to pay for something now than you would have done last year? Every economy out there should have a degree of inflation; it’s a natural part of economic growth
But very much where we are now, bringing things up to current affairs with the COVID recovery, inflation sits above anything else in terms of driving currency demand. The reason for that is, with all the stimulus measures that the federal reserve and the ECB have driven into their economies to stimulate their recovery out of the COVID recession, the fear and the expectation is that all of those will drive inflation. The fear is that inflation may run out of control.
Now, in order to combat that and make sure that it doesn’t run out of control is the central bank’s mandate – the Bank of England, the federal reserve, the ECB and those three territories, to control inflation by their interest rate policy. Very broadly, the higher the interest rates the less money will be spent, because more money will be held in that currency, earning the interest that the central bank payouts on that.
Now, the expectation is that somebody, one of those three territories, will need to move first. That’s driving speculative currency moves. The market is getting relatively frustrated by the lack of guidance over when that change may happen, when the next interest rate move may occur. But every central bank out there is just adopting what’s called a wait-and-see approach to their control. It’s because nobody knows. Nobody knows what the impact of all that extra money being dumped into the economy will actually drive through. Yes, already we’re seeing signs of inflation ticking up slightly, but they’re way under the central banking targets at the moment.
The fear is whether or not it drives momentum and potentially will run out of control. But right here right now, no territory is in risk of rising inflation. It’s just something that’s on the horizon, that everyone recognizes as a potential future threat. As a result, the market, which is very right here right now and its attitude, is discussing on a daily basis.
Barry: [00:08:31] Great. We’ve got a question, if I may, from one of the attendees. The question is: the US dollar still the world’s preeminent currency? Is it at risk as other currencies, such as China rise in power and stature?
Paul: [00:08:45] That’s a good question. Yes, it is still the, the global reserve currency. But yes, absolutely, there are concerns again on the horizon, over the challenge of either China or indeed of cryptocurrencies to potentially take the mantle away from the dollar. A lot of that is to do with the dollar debt; how will that be managed and maintained, the relationship between the US and China is obviously a little bit fruity with the potential for another trade war, but also for that of global dominance. The US has been the dominant player in the world economy since WW2. It’s very keen to retain that mantle. But since then, you’ve seen the rise of China and the Chinese economy. Naturally in the economic cycles, there is a strong argument that the next economic leader will be from the East. Naturally the West is a little concerned about that, I imagine.
Ben: [00:09:52] Can I ask him a follow up question? You mentioned cryptocurrencies, of the trading are cryptocurrencies included in that 5 trillion number you talked about before?
Paul: [00:10:04] No. Quite the contrary, the whole point of crypto, and I’m taking a step way out of my comfort zone – I’m by no means a cryptologist or whatever they’re going by these days with the cool kids – it’s completely independent. It’s not linked to any central bank; as a result, it’s not recorded alongside the Fiat currency transactions, which make that big number that we quoted earlier.
Ben: [00:10:31] Can I ask one follow up on inflation as well, then I’ll be quiet? The quantitative easing has been going for a long time. It’s been the response to the financial crisis, it’s been the response to COVID. But you get a real sense that people are much more worried about the prospects of inflation now than they were in the past or with previous rounds of quantitative easing. Why do you think that is?
Paul: [00:10:56] It’s the unknown. If you take a step back to 2008, quantitative easing, which is just the central banks printing money and chucking it into the economy, back then it was to unstick the credit crunch and provide effectually free money in for people to start releasing their assets that were underperforming and just oil the wheels of economic motion once again. Back then everybody was concerned about what the inflationary effect would be, because again, billions and billions of pounds and dollars that weren’t in the economy beforehand were now flooding through the system.
The difference back then is that was very controlled. You’d have heard no doubt of QE being related to bond purchases as a terminology, if you’re into that sort of thing anyway. It’s a very targeted asset purchase scheme that the government will buy, often government bonds, back from the market to provide more funding for the markets to put to use. Where we are now, the government support and stimulus measures, certainly in the US, has gone way past Wall Street onto main street? Every individual in the US has received two stimulus checks over the past 12 months or so, since the beginning of lockdown.
How that is used – obviously the intent was to drive consumer demand from the bottom end of the economy and get things going again. But the effect of that is very unknown. We may see no problem at all. The fed is very comfortable that any inflationary effect that we will see, they’re calling it ‘transitory’, which means it will spike up and then come back down and normalize over time. But the market is naturally very twitchy about that, because there is the risk that as inflation goes up, it doesn’t come down again. Then if you act too late, the action has to be a lot more savage – you have to raise interest rates a lot higher. That will potentially undo all the good stuff that the stimulus schemes have delivered to the economy.
If we unpick the demand side first, what are the key economic data that affect FX movements?
Barry: [00:13:16] We’ve talked about inflation, and the natural progression is to move on to interest rates. I think the attendees here today would probably benefit from hearing you explain a bit about how interest rates in one currency contrary affect the price of that currency versus another with a different interest rate. That’s known as interest rate differential. Say the UK, for example. Kust for argument’s sake, explain it in the sense that if UK would have a 10% interest rate and the US would have a 1% interest rate, what effect would that have on the currency exchange rate?
Paul: [00:13:57] Very simply, Sterling would increase in value. Put it like this: if I had 10 pounds, would I want to put that in a bank in the UK and get 10% interest on it or would I want to convert it to dollars and put it in a US bank and receive 1% yield? That’s the point, the yield on a currency, same as any other asset class that returns to the investor.
In the global economy, you’ve got the balance of the currency exchange rates driven by supply and demand. Again, we always come back to Econ 101. In the event that the US, for example, raises their interest rates first (everybody out there, all the three key territories (US, UK and Europe) have got ultra-low interest rates, ultra-low monetary policy at the moment), and let’s say they increased by 1% even, then all of a sudden all that money ($6.8 trillion a day) would get 1% greater yield if it was in dollars than any other of the currencies.
Barry: [00:15:12] The currency then will appreciate in value.
Paul: [00:15:14] Exactly. The demand would go in, hunting that yield, and the dollar would rise in value.
Barry: [00:15:21] Is there any negative effect of that happening then for the country, that would affect the exchange rate as a kind of second order?
Paul: [00:15:30] Absolutely. You then look at the international trade; ultimately the currency exchange makes a very important part of the cost of international goods. If all of a sudden I want to buy something from the US or I want to buy something from China in dollars, and I’ve got to pay 5% more for the dollars to pay for the goods, the goods become 5% more expensive to me. That’s a very important consideration for many businesses. Generally, the smaller businesses I think don’t pay that enough attention.
Who are the currency speculators and what role do they play? Do they make the market more efficient or distort it?
Barry: [00:16:10] Very interesting. Let’s move on now. We’re going to talk about the participants a bit more. The markets effectively are broadly broken down into speculators, who are making bets basically. They’re individuals, spread betters, CFDs, hedge funds, trading houses, prop companies – all this stuff. They form a significant part of the market. But the other side of that is real users – they’re changing real money because they’ve made income in a foreign currency and they’re repatriating it, they’re hedging, they’re doing real activities.
Start with the speculators. The vast majority of speculators lose money for a start in the market, right?
Paul: [00:16:54] You’ve seen my trading account, then!
Barry: [00:16:56] In fact, there’s a saying amongst spread betting companies, the 90/90/90 rule. 90% of their clients lose 90% or more of their money within 90 days. This is a widely known maxim.
What role do speculators play in the market, and do they make it more efficient or do they distort it?
Paul: [00:17:21] That’s an interesting question, because speculators as a category is very broad – from the bottom end of the market, like me doing CFD trade and losing 90% of my money very quickly.
The intent there is, I think something is going to happen on that currency exchange. I’m going to put some money on it, wait for the change to happen, and then take my money out. That’s a speculative trade from end to end. The difference between me and let’s say a hedge fund manager, is the size of my budget and how much I back myself that I’m going to get it right. I may bet 10-15 pounds and lose it very quickly; he may bet 10 or 15 million or more. 100 million, whatever the size of the fund is.
The impact that speculation has on the market is huge. It’s a key driver. Where earlier we were touching on the driver being inflation rate and interest rate policy, and the expectation of when that move happens, then the currency is going to increase. Speculators want to get in into the position way before that decision, then move the market. The speculative side of the market is always second-guessing and trying to front run positions, get into the position way before anybody else.
If I take a view on the dollar, for example, today, and buy my dollars, and then you have the same idea after we’ve had a beer in the pub, “Yeah, you know what, I’m going to get into the dollar as well.” You buying into the dollar helps my position, because you’re increasing the demand after I’m already holding the asset. Everybody’s trying to get in ahead of the game.
What advice do you give exporting and importing SMEs when it comes to navigating FX markets?
Barry: [00:19:14] The other side of the spectrum then, can explain how a real company, import/export company, would use the currency market? Especially around mitigating risk in the future?
Paul: [00:19:32] That was exactly what I was going to say, the business mentality. Is your business speculating on currency? No, you’re not a hedge fund, you’re not a bank, you’re not a trading floor. You’re buying widgets and selling them and making your profit on the difference. The focus should be different, and to a degree you should try and ignore the noise of all the speculation and the market movement and the opportunity, because with opportunity comes risk. Ultimately running a business, the FX exposure to your business should be seen more as a risk than an opportunity. Yes, if you left your position unhedged or uncovered and just waited until the invoice was dew, the market may move in your favor and you may get cheaper dollars for example, and as a result your goods that you’re buying from China may get a little bit cheaper – which would be great. End of year accounts, you’ve done an FX profit line item in your accounts. But the opposite could ruin your business.
We had so much market volatility in, I think it was March last year, COVID related – all the uncertainty, going into lockdown, what is this new virus? The markets were all over the show. A lot of players got caught out, and you’re looking at millions and millions of dollars of loss on those exposures.
Barry: [00:21:05] With your background, Paul, you’ve seen thousands and thousands of companies using your services for currency exchange and hedging. What’s the biggest bits of advice you’d give to any import/export company for how to navigate the FX markets and FX risk?
Paul: [00:21:24] Personally, I encourage any client to move away from the market noise. On one hand, it’s the market noise of speculation, on the other hand, you’ve got a hundred brokers out there with a hundred sales guys making a hundred calls a day, promising cheaper currency to hook the clients in. It’s just distracting. I’ve been there. I was that guy too many years ago, to share with you.
The merry-go-round that the client journey went on as an FX sales guy was, quoting really tight, show them amazing savings, get them on, and then start to sweat the book. Effectively make their FX price worse and worse over time, and you monetize the client better as the relationship goes on.
I genuinely feel uncomfortable about that. My view is that every service should have a value. Price is only an issue in the absence of value. My intent is to speak to business owners about their business, about their flows, about their risks, and then really curate a policy with them (of course with their buying, because it’s their business at the end of the day) that delivers their business goals for, for example, the next budget period of 12 months or whatever. Then you can very easily take contracts, either forward contracts, participating forward options. Again, that’s why Currency Transfer integrated with the short hedge, to get the option product onto our platform. It’s what I call part of the healthy breakfast. Some spots is a good thing. That volatility or that exposure to price movement may tick a box for some business owners, because there’s a pun to every entrepreneur! But then you look at typically the finance director, who’s been brought in to steady the ship, and the discussion around hedging and taking risk off the balance sheet is really speaking to that type of character in a business.
I just play the role of MC in that discussion, and work out like what matters, who’s got the biggest claim to business strategy; and we take all of that offline and deliver a tailored strategy for them to consider. If they want to execute it, then amazing. You’ve taken the FX risk out their business for the next 12 months.
FxPlew’s Market Brief
Barry: [00:23:53] We’ve got a question in from an attendee now. Everyone’s fascinated with the FX Plew market brief on the air wheels.
Paul: [00:24:01] Not sure everyone!
Barry: [00:24:05] There’s a question here. Where do you actually film the daily market brief?
Paul: [00:24:11] Well, it started in the office. I used to be suit-and-tie behind a desk, delivering the news. The archives are still there, look them up if you want to. But we have evolved since then. It kicked on when I started filming as part of my commute. I get on this little air wheel, it’s a little bit like a Segway, and scoot through Green Park on the way to my office in Victoria, just chatting into a selfie stick.
That seemed to get a little bit more interest, probably more from a ‘where’s Wally today’ perspective, but I’ll take it no matter what. Then lockdown happened, and I deliberately live a little bit out of town. I scoot around in the trails and the public footpaths out behind my house.
Ben: [00:25:02] We’ve had one other question from the audience. I think, sadly, this might have to be our last question. Early on, you and Barry were talking about interest rate differentials. I guess this is what has prompted this question, which is, given that the action of one central bank can determine the price of currency relative to another country, how much do central banks coordinate action to produce that kind of ethics between currencies?
Paul: [00:25:30] That’s a good question. The answer, honestly, is I don’t know. I’ve never sat around a central bankers table and been party to those discussions. But I think it would be shortsighted to assume those conversations are not going on.
Again, at periods like 2008 in the credit crunch, where the world economy was looking at this black Swan event that we don’t know how to do deal with this because it’s never happened before. The idea and the commitment to printing all this money and dumping it into the economy had to have been coordinated. The timing of that was different. Again, maybe not. Maybe it was the US leading the UK, going, “Yeah, we had that idea. It’s working over there, we’re going to go forward as well.” The Eurozone, if memory recalls, was denying everything – we don’t a problem – living in denial for too long, and then actually jumped on the bandwagon themselves and started printing money when their bank started falling over.
I think it’s a similar story during COVID. It’s a global pandemic, it’s a global issue, and the solution, although every territory I believe to be inherently selfish first. You’re looking at your own economy, how are you going to get it done? But if you don’t also have one eye on the net effect of other important territories, I think it’s probably shortsighted.
Barry: [00:26:56] Ben, we have another question.
Ben: [00:26:57] Yeah. I feel when they come in from the attendees we should take them. Maybe make this one the last one.
Barry: [00:27:03] Question for Paul. We have seen a major strengthening move in the EM markets over the past few months. Do you think this will continue? If so, for how long? Orr alternatively, why would it run out of steam?
Paul: [00:27:17] To cut through the jargon, EM is emerging markets. which are generally the smaller economies out there, past the G7 nations, for example. Yeah, they have strengthened. Typically, they’re viewed against the dollar, and that move has been driven I would say more by dollar weakness than emerging market currency strength. That comes back to the ultra-loose monetary policy that the US is committed to at the moment, the trillions of dollars that they’ve dumped into their economy that naturally has a weakening effect on the currency, since Biden got his way with the Biden bill as soon as he took over in the White House.
How long/will it run out of steam? I think it will run out of steam, yeah. The timeframes on that, again, check my trading account record before you wade into any positions on the back of this, because it’s not advice, that’s a big question about when. The market at the moment is largely sitting on its hands. Every year there’s a summer lull anyway, and it looks that we have stepped into the summer lull maybe a month earlier than previous years. A lot of that is because the market isn’t getting enough forward guidance or enough clues from the fed over when they are considering starting to tape a QE and maybe raise interest rates.
I think the dynamic in the market is one of quietly expecting a dollar rally to come, probably as a next move. It’s relatively weak at the moment. The recovery story is going pretty well; the inflationary pressure is there. So the expectation for monetary policy adjustment to combat that is at the moment balanced towards the US being the first mover. When that happens the dollar will strengthen. That for me will probably signal the end of the current emerging market currency strength.
Ben: [00:29:26] Fantastic. Sadly, we have run out of time. Paul, thank you so much for your insights. Barry, thank you so much for steering the conversation. Thank you everybody for attending this first live conversation. We’d love to get your feedback and what you think, if you’ve got constructive feedback please drop us an email or drop us a post on social media. Just one date for your diary. If you want to attend this again live, on the 23rd of June at the same time, at 8:30 UK time and 9:30 Central European Time. We have Mike Sullivan, who is the former CEO of Credit Suisse, and he’s author of The Leveling. We’re going to be talking about FX markets in a post globalization world. Please check that one out, that’s on the 23rd of June.
Paul, Barry, thanks again for your time. I certainly found it super interesting, I’ve taken loads of notes.
Paul: [00:30:22] Are you not going to ask them all to like, comment and subscribe?
Ben: [00:30:28] Yes! Like, comment, subscribe, give us a five-star rating if you’re listening on Spotify, et cetera. Also, I nearly forgot to say please check out FX Plew, and please check out the daily market briefing.
Paul: [00:30:39] Thanks too kind, thank you very much.
Ben: [00:30:43] We’ll have you back on soon, thank you Paul. That was great.
Paul: [00:30:45] Thank you very much.
Barry: [00:30:48] Thanks Ben.