2019 Outlook

Podcast Series

This series within The Treasury Update Podcast features interviews with treasury experts about their expectations, projections, and predictions for the year ahead.

Series Host

Craig Jeffery

Q2 Corporate Investment Outlook

 

On this episode of the 2019 Outlook series, Craig Jeffery sits down with Executive Director Bob Leggett and Senior Portfolio Manager Mike Cha of Morgan Stanley to discuss the 2019 Q2 Corporate Investment Outlook. They take a deeper look at the major shifts in short-term investing, the use of various instruments, and a number of macro shifts continuing to take place this year and beyond. Listen in to the discussion.

Bob Leggett

Executive Director

Morgan Stanley

Mike Cha

Senior Portfolio Manager

Morgan Stanley

Episode Transcription - Q2 Corporate Investment Outlook (Morgan Stanley)

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Craig Jeffery: Welcome to The Treasury Update Podcast. This is Craig Jeffery, and our session today is the 2019 second quarter Corporate Investment Outlook. I’m here with two gentlemen from Morgan Stanley, Bob Leggett and Michael Cha. Let me give a quick statistical summary of Morgan Stanley for the few of you who may not know. Morgan Stanley is a global financial services firm. They cover investment banking, security management, wealth management and investment management services. Their clients are corporations, governments, financial institutions and individuals. They have offices in more than 40 countries and have over 55,000 employees. And, their assets under management exceed $470 Billion. Welcome to the podcast Bob and Michael.

Bob Leggett: Thank you.

Mike Cha: Thank you.

Craig Jeffery: Bob is the Executive Director of Morgan Stanley Investment Management. He is a liquidity strategist for their global liquidity business. He has over 25 years industry experience and joined Morgan Stanley in 2015. Michael Cha is the Senior Portfolio Manager. He is part of Morgan Stanley’s Global Liquidity Team. He also has over 25 years of industry experience and joined Morgan Stanley back in 2008. But let’s begin by taking a look back over the last couple of years and through the first quarter of 2019. We have seen several major shifts in short term investing over this time, and the use of different instruments this is, been brought about in part or a reflection of some regulation changes. We’ve seen money flowing into and out of different instrument types due to some different activity on the ground if you will. What do you see as the primary causes for the changes that were out and in and different instrument groups in 2018 and even in the beginning of 2019?

Bob Leggett: Thanks, Craig. I think there’s really three themes that capture the asset movement. The first one is, thinking back to 2018, was the environment. So you had an environment where volatility was increasing, particularly in the latter half of the year. It led to poor performance for fixed income and equity strategies. And, you saw cash, if not the best, then, one of the best performing asset classes last year. So, I think the fact that you had more market volatility led to stronger flows into cash investments and, particularly, money market funds. I would say the second theme was the deposit beta environment. On the banking side you had slower deposit growth, which was driven by broader economic concerns, and a fed that was starting to reduce the size of its balance sheet, which in theory slows money supply growth and ultimately deposit creation.

Bob Leggett: You have a yield curve, which had been flattening, which puts pressures on Net Interest Margins. And, in a flatter yield curve environment banks are looking to protect their NIMS and are generally going to be less inclined to pass through rate increases to their deposits. Now, compare and contrast that to the money market funds, and there you saw funds yields were broadly keeping pace with rising short term interest rates. So effectively the rates are being passed through almost immediately, and it’s leading investors to evaluate, I think, the trade-off between funds and deposits. I would say in many cases investors found that they were able to invest in a higher quality portfolio (i.e. Government Money Market funds vs Deposits) and earn higher yield as well.

Bob Leggett: The last thing that we saw in 2018 was a resurgence of demand for what we call here at Morgan Stanley Conservative Credit Strategies. Conservative Credit it to us is, it’s being packaged in a number of different product wrappers, including Prime Money Market Funds, Conservative Ultra Short Duration Bond Funds, Private Placements, and Separately Managed Accounts. So, you saw in 2018 probably a little bit more than $100 Billion come back into Prime Institutional and Prime Retail Funds. But, if you looked at that number just in isolation, I think that underestimates the demand, because you had significant growth in Conservative Ultra Short Duration Bond Funds, probably somewhere in the neighborhood of $50 Billion. And just to be clear, we define Conservative Ultra Short Bond Funds as funds that really limit their investments to primarily Money Market Eligible Securities, limit their investments to Investment Grade only, and have generally shorter Weighted Average Maturities, let’s call it, three months, and Weighted Average lives approximately six months or less.

Bob Leggett: There was a lot of demand in that category as well. Just thinking about prime, I would say, investors have come back into the space, because they have seen limited NAV movement since reform. I think they’ve recognized that liquidity in the products has been consistently high, more than the 30% prescribed liquidity, which is required. The industry scale has returned, so if you look back to the fourth quarter 2016, there was probably five funds that were over $5 Billion. That number probably closer to 13 to 14 today. And lastly, I think investors have recognized that by moving into Prime and out of other strategies including Government Money Market Funds, there is real yield pick-up. You’re able to pick up somewhere between 20 and 30 basis points of extra yield and still satisfy primary objectives that liquidity investors have, which is principle preservation and liquidity.

Craig Jeffery: What was that gap back in 2016 or a year prior, prior to the flow back in?

Bob Leggett: I think that gap was probably closer [to] 10 to 15 basis points.

Mike Cha: Now, I was going to say that the historical average on spread between private and Government Money Market Funds over a long period of time, I know I can be compressed [and] it can widen, but it’s probably about 20 basis points.

Craig Jeffery: Okay, so you see it moving back towards the historical norms and, therefore, monies flowing back in as part of that?

Mike Cha: That’s kind of where we are right now. We are at about 20 basis points of yield pick up between Prime and Government Money Market Funds. I think the most recent developments in the market place that Bob alluded to and something that we will talk about shortly, as far as some of the macro shifts that we’ve seen recently, may actually bode to setting up a scenarios where those spreads compress. When you have a situation like that, the big question for users of Money Market Funds, as well as managers alike, is ‘What will be the behavior of the client base if that spread does start to compress?’ One of the things that I think is clear [is that] there are some clients that will require some self-imposed spread between the Government Money Market Fund and a Prime Money Market Fund, but, I think there will be a big swath of investors that are comfortable with the Prime Money Market Fund as an asset class and as a product type. And, if they can get a decent pick up, maybe ten basis points, they are still going to remain in the fund.

Craig Jeffery: Thanks for that summary of the key reasons money is flowing back into some of these other fund types, like Prime Funds. How much of it do you think is driven by the increase in rates, and how much of it do you think is based upon the volatility in other instruments? Or, is it just hard to allocate the different weightings of those factors?

Mike Cha: No, I think they are all very important. I don’t know if it’s necessary to weight those factors. I mean, clearly you would think that if there is increased volatility that if investors want to park their money and wait out for direction in the market with more conviction that Money Market Fund is a good place to park their cash. But, as we alluded to earlier, throughout this rate cycle for the last couple of years, it was a completely different proposition when you are talking about a zero-interest rate environment where cash was not returning much of anything. From a policy prospective, that is by design. You don’t want people to sit on cash; you want people to go and deploy capital. That’s why rates are set at those levels by the central banks, and the amount of accommodation that is built into the system is to incentivize folks to put capital to work. With the rising rate environment that we have seen and all the higher policy adjustments, policy rate adjustments, as we alluded to earlier, cash is now an asset class again and to consider.

Mike Cha: If you just look back, even in this past year, and, I know some of the questions have references multiple years, but just this past year, if you look at the performance of cash compared to some of the other strategies out there, it’s done extraordinarily well. So, it is an attractive investment even notwithstanding some of the dynamics that we described as far as market volatility and the safe haven for folks capital.

Craig Jeffery: Yeah, excellent. So, just shifting from the backward look to looking forward as we look deeper into 2019, as we finish the first quarter and move into the second quarter, there have been a number of pretty major shifts that are taking place some of which you comment on. I was wondering if you could expand on the context of some of the investment decisions in light of some of the things that happened in December and some of the guidance provided by the Fed recently. And maybe what you could do is give us an inventory of some of those macro events, and we can jump into any of them in detail that makes sense?

Mike Cha: Sure. I think the point that we’re making,the major shift has been the outlook, and the policy shift of the FOMC. Up until the December meeting when they actually did tighten by 25 basis points, it almost felt like the market was almost on automatic pilot, and a Fed policy, with a near term, was also on automatic pilot. And, when I say automatic pilot, I’m saying it was the major quarterly policy meetings where, I think, what they were touting as well as what the market anticipated were largely inline. But again, with the volatility that we saw at the end of the year and financial conditions tightening up dramatically in a series of really kinda bad news, if you will, for the market place. The Fed has completely pivoted and now the outlook looks dramatically different than what they were advertising, if you will, back in December.

Mike Cha: Since that time, clearly, there have been developments, whether it’s in Europe or whether it’s in China, both of those Central banks and the outlook was revised downwards. The Central bank in Europe, the ECB, has also, at their most recent meeting, described how the outlook was negative and needed to perhaps inject a little more accommodation, so they are going to come out with, they announced that they are going to come out with another financing package for banks to incentivize lending. So, if you pull all that together with the trade tensions that’s out there as the trade negotiations between the US and China are being negotiated as well as the uncertainty around Brexit, it seems like the Fed had enough meat on the bone, if you will, to take a pause. And, that has been their message and their messaging is that they will remain patient and see how things develop.

Mike Cha: One of the things that they absolutely wouldn’t want to do is to make sure that the economic recovery that we are seeing in this country is sustainable. And, it seems like that is taking a paramount or a priority, if you will, over their other two mandates, which is employment and price stability.

Mike Cha: The last meeting, what we did see, was the Fed clearly stating that fact. They want to support the sustainability of the recovery, but they also acknowledge that look we are part of a large global economy, therefore we can’t be, I guess, insensitive of developments that obviously would impact us in the future.
Craig Jeffery: Yeah, that’s interesting. Let me ask you a couple of questions on a few of those. Let’s start with the Feds plan to raise interest rates. They moved down their auto pilot in the number of times they expected to raise rates. That guidance you gave in terms of patience is there. I think, the expectations is that there are no expectations of increased interest rates from the Fed now, is that pretty standard?

Mike Cha: Yeah, if you look at the most recent median dot plot out of the Fed, they revised it to no policy adjustments for the remainder of 2019 and one interest rate hike in 2020.

Craig Jeffery: Yeah, definitely more muted that six months ago, right?
Mike Cha: Oh yeah, six months ago we were talking about three rate hikes in 2019. The terminal rate for 2019 back between September and December was calling for three rate hikes in 2019.

Bob Leggett: It’s interesting just the magnitude and how quickly the market recasts its expectations around that policy, as Mike noted.

Craig Jeffery: Are you referring to like December what occurred and how quickly the adjustment followed?

Bob Leggett: Exactly, if you looked at curves in the beginning of December, end of
November beginning of December, there was at least one rate hike priced in for 2019. Now we find ourselves with one ease being priced into the market.

Mike Cha: Now that one ease is basically priced in by again, Bob said, the market. It’s not what the Fed thought plot would indicate, but clearly there seems to be somewhat of a dislocation between what the market is pricing in and what the Fed has said, vis-à-vis their dot plots. But, that phenomenon, I would just add, is not completely surprising, because, throughout this whole rising rates cycle, if you will, what the Fed adjusting policy rates higher, the market has lagged, generally speaking, as we approach those Fed meetings. So not until right up against those Fed meetings have we seen the markets fully price in those hikes, but there was a lag certainly.

Craig Jeffery: I am definitely going to add the Fed dot plot phrase into my lexicon and try to use it a couple of times in the next week so that’s helpful on a number of fronts. But, with the interest rates. As you look at the yield curve, normally it’s upwardly sloping to account for the time value of money. The longer you have it held, the higher interest rate you should have now. You talked about it flattening, what’s its current trajectory?

Mike Cha: I guess we should take a slight step backwards if we’re going to talk about quote unquote ‘The Curve.’ The Curve is going to be a by-product of a variety of different assumptions and expectations, one of which is interest rates and the path of interest rates going forward. And clearly, the Fed is saying there is now, interest rate adjustments, so the path of interest rates should be basically neutral, absolutely flat, if you just look at what the Fed is pricing in. But, as Bob alluded to earlier, if you look at basically something like the Feds Fund Futures of the OIS curve, that is actually pricing in some percentage of probability of a rate cut because it is inverted. From a pure expectation of what we think, or what the market perceives, to be the path of interest rates at best, they should be flat, but, like I said, the market is pricing in some type of easing because it is inverted. If you move away from the interest rate variable, you need to take into consideration other factors like liquidity, that clearly is a consideration, as well as credit.

Mike Cha: If we anticipate that clearly the liquidity premium is going to be worth something, so you should have a natural positive slope associated with the liquidity premium. And then from a credit perspective, obviously the longer bet you make on credit albeit our higher curve is out to a year but it could be meaningful. And that all should contribute to the fact that the curve should be positively sloped. If you boil all that together right now, the curve is very flat again. I think the outlook on the interest rate part is actually overshadowing or taking a dominate role as far as the variables that I laid out.

Craig Jeffery: There’s a few things on Quantitative Tightening. I wondered if that’s something you wanted to comment on in terms of the Fed moving to Quantitative Tightening and doing it essentially. I think Powell indicated it was on autopilot or maybe that was just the description of it, to the tune of about $50 Billion a month put back in the Market? Now, that being moderated as well it’s no longer on autopilot and know the European Central bank and Bank of Japan are not in Quantitative Tightening, not underlining their asset purchases that they’ve made. Any comments on that in terms of how that’s impacting elements and end rates?

Mike Cha: Well again, I think it’s a part of the dovish sentiment and it plays right into their outlook right now for basically the position of trying to remain accommodative to maintain the sustainability of the recovery. The balance sheet normalization is definitely going to end. That announcement was made. It’s going to end at the end of September. But, even perhaps, another detail, though, that shouldn’t be overlooked is that there going to start tapering in May. So, they’re going to reduce the amount that they’ve been normalizing in the balance sheet by half, and it’s going to basically end at the end of September. One of the things that Powell mentioned in his press conference as well was just how large the Feds balance sheet will be in the near term, and,once this is all said and done, the projection and supported by his own comments was something North of just three and a half trillion.

Mike Cha: As far as it’s impact on the outlook for rates, obviously the fact that they stopped normalizing and they’ve indicated that there willing to be on hold, as far as adjusting policy rates in the near term certainly over the next two years only one policy adjustment indicated by the dot plot. You’ve seen what’s happened to the yield curve. So, both those actions, the announcement about the balance sheet normalization and when that’s gonna end as well as the outlook for policy rate increases, have clearly put downward pressure on rates.

Craig Jeffery: Anything else on balance sheet normalization or other macro impacts that you want to comment on?

Mike Cha: The only thing that I think we can mention about what the ECB had announced is the introduction of a TLTRO Number 3. This is the financing package that I alluded to earlier in the conversation and the details of which we are still waiting for. But again, the introduction of that is an accommodative move. So again, it coincides, like I said earlier, that we have seen downward protections for economic growth, not just in places like China, but certainly in ECB for Europe. And, the ECB certainly has done something about it.

Bob Leggett: The one thing I might add is we talked about the implications of uncertainty leading to stronger demand as for cash as an asset class. I would say just the uncertainties in the global economy are leading to central banks to either pause or potentially ease monetary policy further. You think about what’s happening in England. There, kinda the strategy around Brexit is to just put more time on the clock. But, as they put more time on the clock that creates a level of uncertainty for the economy, and it’s going to lead to potentially the Central Bank to be on the side lines a little bit longer. China, they’ve effectively been easing, they’ve been adding liquidity to the market in recognition that their economy is slowing. So, they are doing a number of things from devaluing the Yen to increasing the reserve requirements to adding fiscal stimulants and investment incentives and tax cuts. All this in recognition that, hey, their economy is slowing. Collectively, all this uncertainty around the globe, I think, is leading to central banks to say, ‘Hey, wait, lets see how things play out here. There’s a lot of uncertainty in this environment, and we’d rather be safer and take our time raising rates rather than doing it in kind of rushed manner.’

Craig Jeffery: Thanks for some of those detail around the globe, too. Now as we look at what are some of the implications or what should treasures of global multinationals, heads of finance, and treasurers of institutes of higher education, or different industries, what should they be looking at? Looking to do throughout the rest of 2019 to be able to respond to or adapt different changes that are planned or otherwise, what’s a good course forward? What should they be doing or looking to do?

Bob Leggett: Yeah, that’s a great question. It’s interesting because, I think, what all of us have lived through, at least through the last ten years, has been a period of disruption and industry transformation. That’s changing the dynamics of the liquidity or the funding markets. Thinking about just the forces of disruption over the last ten years you’ve had negative and zero interest rates. You’ve have Quantitative easing. You’ve had banking reform. You’ve had repatriation. And, you’ve had Money Market Fund reform. All this is leading to changes in how banks have funded themselves, as well as utility of different product types. So, what we’re telling our clients more than anything is that you need to be flexible or adaptable. You need to think about your investment policy being flexible and adaptable so that they’ll be better positioned to capitalize on market dislocations and to pivot to allow companies to pivot to strategies that will still emphasize principle protection or liquidity but might offer better risk and or returns for investors.

Bob Leggett: And, just to give you a couple of examples, there’s a lot of clients whose policies just contemplate deposits in government Money Market Funds. It might make sense to look at other strategies such a Prime or Conservative Ultra-Short Duration Bond Funds. Are there other strategies that make sense? There [are] strategies that focus on credit transformation that could be appropriate. What I mean by that is, there are security types that offer the same exposure to an issuer, however, that security is collateralized rather than unsecured. So, if you’re comfortable having the risks to the issuer and you can earn a slightly higher yield and receive the benefits of collateralization, that’s something that you might want to consider.

Bob Leggett: Are you doing it? Are you getting exposure to that issuer in a safer form and potentially with a higher yield? We also just tell investors that cash is likely to remain an asset class that’s going to be important to your portfolio, particularly given the shape of the yield curve and the uncertainty that we have been talking about in the market place. So, are there strategies that can be a compliment or a substitute to what you’re doing today? And, I think you need to consider those, but the important thing is you need to adapt and evolve, because the markets are adapting and evolving.

Craig Jeffery: Based on the expectation on interest rates, and some of these other economic factors, do you expect funds to continue to flow into Institutional Money Market Funds or Prime Money Market Funds throughout the rest of this year?

Mike Cha: Yeah, just to support the fact that our assertion that cash is now an asset class again, we have seen pretty healthy inflows into certainly the Prime Money Market Funds and Prime Money Market Funds have always been discussed with our client basis as kind of more strategic or core cash. The daily in and out or daily cash needs should be supported by their use of Government Money Market Funds. So, it kind of correlates with they enjoy the higher yields and, again, at this point, look the prognosis is that there won’t be any rate hikes so, even if rates stay where they are, I think even from a conservative investment stand point or a place to park your cash safely and earn the kinda yield that your earning right now makes a lot of sense.

Craig Jeffery: Excellent, I want to thank both of you for your comments as we look at the 2019 corporate investment outlook, really Q2 and beyond. Any final thoughts?

Bob Leggett: I don’t know if we have any final thoughts. The questions that we are asking ourselves are what products that think are clients looking to as the markets adapt and evolve, and it’s really difficult to create a product that’s differentiated in the market place. We do see a lot more interest in Bond Funds as a complement to other liquidity strategies. The separate account world, I know we talked a little bit in the past about this, but separate account strategies, unclear from my perspective on kind of the growth in those strategies. And, if you think about historical growth I think it was driven by the rate environment and where that cash was located. So, if you look at kind of the 20 largest multinational corporations, they had more than a trillion dollars of liquidity on their balance sheet. That number has been coming down, and if that number has been coming down, then, maybe the growth of separate accounts is either going to be flat or slightly down. So, what we try to do is think about solutions that are appropriate for our clients and we will continue to think about what those solutions might be, but it’s a challenging exercise.

Craig Jeffery: Bob and Michael, thank you for joining me on The Treasury Update Podcast.

Bob Leggett: Thank you we appreciate it.

Supply Chain Finance Outlook

 

On this episode of the 2019 Outlook series, Craig Jeffery speaks with CEO and President Cedric Bru of Taulia on the continued evolution of supply chain finance.  Growing awareness of and access to SCF technology has democratized financing options such that even small organizations can now benefit from the network effect of these tools.  Cedric shares insights into Taulia’s global expansion as well as his take on how companies can manage working capital and optimize cashflow.  Listen in to discover what organizations need to know about SCF in 2019.

Cedric Bru

CEO

Taulia

Treasury Management & Technology Outlook

 

On this episode of the 2019 Outlook series, Craig Jeffery sits down with Paul Higdon, Co-CTO, and Michael Kolman, Head of Business Development, of ION Treasury to discuss their expectations for 2019. Paul and Mike provide insight on the reemergence of money market funds, LIBOR, the rise of open banking, predictive technology and machine learning, while explaining their notable significance from a treasury management perspective. Why should treasurers be aware of these topics and what will be their impact on their organization? Listen in to find out.

Mike Kolman

Chief Operating Officer

ION Treasury

Paul Higdon

CO-CTO

ION Treasury

Episode Transcription - Treasury Technology Outlook (GPS Capital Markets)

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Craig Jeffery: Welcome to The Treasury Update Podcast. This is Craig Jeffery. And we are in the middle of the 2019 Outlook Series. I’m here with ION Treasury. ION is one of the largest treasury management systems technology providers. They have seven core products, which you may be familiar with. This includes Treasura, ITS, IT2, City Financials, Reval, Wallstreet Suite, and Openlink. I’m talking with Michael Kolman, who’s the Chief Strategy Officer. He’s based in New York. He’s been on the FinTech HotSeat at the AFP with us. And also, Paul Higdon, he’s the Chief Product Officer. He’s based out of London. But he’s sitting with Michael in New York today. Welcome to the podcast, gentlemen.

Mike Kolman: Thanks for having us, Craig.

Paul Higdon: Good morning.

Craig Jeffery: This series, we’re covering a number of items, and I’ll just give the listeners a quick overview. We’re going to talk about Libor as a replacement, what’s replacing Libor, an aspect of the money market fund changes. We’re going to look at APIs. And then we’re going to focus on predictive technology, and some of its applications. And then we’ll circle back and end with what organizations are doing with communities. So, first, I want to cover technology and treasury process implications in the context of a number of changes that are taking place during this next year. And as we start with the benchmark rate of Libor, which is used in so many contracts. Libor is going away. There’s the end date of 2021 looming. Over 350 trillion dollars worth of derivatives, bonds, and loans are benchmarked off of this rate. So, Mike, I’d like you to just give us your take on what’s going on with the Libor replacement, and what do we need to think about from a treasury technology perspective.

Mike Kolman: Well, I think the 350 trillion dollar number is certainly a gigantic number. But what’s actually, I think, even scarier is that it likely understates the value of the outstanding contracts, where IBOR’s embedded. So corporations have revenue, supplier contracts, lease contracts, pension policies, insurance policies, all with Libor IBOR referenced mechanisms embedded in them. It’s also important that we don’t ignore the IBOR based intercompany loan portfolio, or in-house deposit and loan agreements that also reference IBOR to facilitate their in-house banking activities. And in addition, for items placed on the balance sheet that are on the balance sheet at their fair value, the valuation, the cash flows that impact that fair value are likely also discounted off of IBOR, adding, really, another element to the entire Libor exposure picture.

Craig Jeffery: The impact, the number of assets and activity that’s related to Libor and some of the IBOR ratings is enormous. It’s very significant. But what should companies do? Or what should they be getting started on to deal with this change, whether it’s for intercompany or external contracts?

Mike Kolman: Yeah, it’s almost like that understanding where your exposures are, you really need to go out and turn over every single stone, and really look to understand where Libor exposure could be present. And so, I think with the end date of 2021 looming, as you said, it’s really important to start now. And so we’d recommend really focusing this calendar year on understanding where your exposure is, and beginning to develop a strategy on how to address each of the items. So there’s still some unanswered questions with regard to the whole IBOR replacement. We would recommend that you speak to your advisors. Big Four briefings, ISDA evolutions, reading blogs, whitepapers, and really just begin, if you haven’t already done so, to educated yourself, because the impact will be quite significant.

Craig Jeffery: So if 2019 is a time of exploring and gaining information, how do you turn the page and look at strategies? So what guidance would you give on laying out that strategy to move towards a replacement once you’ve gained insight into what’s one of the best minds with thinking with regard to this change?

Mike Kolman: Well, since the exposure, internally, in the organization, is so far reaching, it’s important to really get the key stakeholders involved. Really raising this to the C-suite level, to raise awareness internally, is really quite critical. So the key stakeholder groups that are likely to be involved would include the general ones that you’d expect, treasury group, accounting, procurement, legal, tax, IT. And as I mentioned, speaking to auditors, advisors, and really making sure that the business units themselves are also aware that this is going on, and raise anything to that group that is really leading the charge, that stakeholder group. If you’re successful in doing this, you should really be able to understand what that exposure is, and then begin to break it down, and create strategies to manage the implications of each of the items.

Mike Kolman: In terms of strategies, I think one clear one is understanding what exposures will live beyond that 2021 date. So for any contracts that do live beyond the 2021 date, there should be planning and anticipation that they’re likely going to require and then mince. And some re-papering work should be planned. This could be time-consuming. It could be costly. And, it might result in certain decisions to refinance. I think that there’re, in a number of contracts, fallback provisions in the events Libor, as the reference rate, may not become available. This is most likely, I think, what all the experts are saying, is likely insufficient. It’s unsustainable in the current agreements. And so this is certainly a key area. In ISDA agreements, ISDA is meeting to define really how definitions will change. So it will be important to follow along.

Mike Kolman: All of that is external, and your ability to control that is somewhat limited. Your ability to control, actually, for your inner company loan portfolio is much more within your control. And so for this, a general approach could be that you amend loan agreements with the replacement rate, and agree on a somewhat of a transition dates. So, any interest periods that would start, let’s say, after a transition date, would use the replacement rate. And this way, you’re sure to be able to have a rate available. And also, you’ll be also be able to maintain that arm’s length lending standard. Also, when it comes to valuation of derivative agreements, specifically on swaps, this can also get a little tricky. And, so it’s important to understand and ask yourselves, within the organization, some certain questions to define what you really need to consider.

Mike Kolman: So for example, will you need to maintain historical valuations of these securities. This can get a little tricky as you get to that period of transition where part of an agreement might actually be referencing a Libor rate, and another part of the agreement might actually be referencing the replacement rate. And, you need to plan that transition appropriately, so that you actually maintain the accurate historical valuations.

Mike Kolman: Another consideration is how can you adjust the spreads for the changing benchmarks so that your fixings are accurate. This might involve updates to the systems where you manage certain agreements. Is there a central source that provides rates for your organization? So, for example, does treasury provide IBOR rates throughout the organization as the central source and provider? So, you need to update and maintain the processes for those as you distribute new rates. And, reaching out to your technology partners, internally, externally, speaking to your peers is also going to be another important aspect of this whole transition.

Mike Kolman: And then finally, the other consideration is on future funding strategies in the next three years as we’re approaching 2021, and whether or not, as you put new agreements in place, you want to continue to reference IBOR. Or, if you will begin to adopt the new, risk-free rates, which would be the replacement rates, as it pertains to risk management activities, technology capabilities, and hedging decisions. So, with that, there’s a lot to consider, which is why, in 2019, you should really take advantage of the time to understand, wrap your arms around really what your exposure is, because that’s the starting point for all of this.

Craig Jeffery: Yeah. There’s certainly a lot of complexity there with those changes, especially for longer term instruments that roll over the sunset of Libor. Let’s shift to money market funds, now, as we’re talking about interest rates, short term rates. Money market funds, institutional money market funds, really began reemerging in a significant way during 2018. Rates have risen, pulled a lot more companies back into this asset class, a lot more assets flowed back into there. Maybe you could talk about some of the changes in the institutional money market fund space that are making it more attractive, and more complex, following the financial crisis of years past, and some of the regulations that came forward.

Mike Kolman: Yeah, I think it’s a great point. Certainly, the financial crisises had changed a lot in the worlds of corporate treasury, in terms of keeping more cash on hand, liquid, in short term investments. Obviously, at the same time, we also saw interest rates go to zero, or sometimes negative. And now we’re getting to a period of time when we’re seeing interest rates come back. And, in the movement of funds into money market funds, is actually been quite interesting. And so I was just looking at some data before this podcast. And, there are three trillion dollars invested in money market funds. 190 billion dollars of new funds flowed into money market funds during the fourth quarter of last year, of 2018. And this has really been the highest inflow of funds since the fourth quarter of 2009. So it is quite interesting to see this, and it’s not surprising the flow of funds is coming now, because rates on the money market funds are somewhere around 2.5%. Following a period of time when rates were at half a percent until early 2016, and now, breaking the 2% mark in mid-2018.

Mike Kolman: The other implication that we also saw was with money market fund reform. And so, when we look at the impact that that had, the investment in money market funds really took a dramatic shift from large institutional funds, and into government treasury retail funds, following this reform. And the reform introduced the concept of floating net asset values, or variable net asset values, or NAV, for the large institutional funds. Which is different from the government treasury retail funds that are still have a stable net asset value.

Craig Jeffery: Yeah, let me ask you a question on that, Mike. With that change to floating NAV, as assistant provider, you had to make some changes for that. What did you have to do? Just give us a glimpse into what you’ve had to do to adapt to this change in operating models for these funds.

Mike Kolman: What change really is, the price of the fund was marked at a dollar, for stable net asset value funds. So the switch to floating NAV, that one dollar share price changes. It floats, just like the name implies. And so, in order to accommodate for the changing valuation, bringing in certain money market fund factors, updating the price, and all the downstream implications, in terms of valuing the underlying investment, your overall investment in money market funds, accounting for valuation changes, all had to be updated. So, while we made the technology updates required to manage the floating net asset value funds, what we saw was not a very large uptake in that functionality, because while the functionality provides the support to manage it, at rates that were half a percent or even lower, a lot of companies, like we saw, where the flow of funds went, was really more towards those stable net asset value funds. And so we didn’t see the uptake of the floating net asset values, even though we provided management for that in our technology solutions.

Mike Kolman: Now, as we fast forward to today, where rates are at 2.5%, they are attractive, perhaps the large institutional funds are becoming more interesting to corporations who may be willing to adopt. So, I would urge others to contact their technology partners, and review what capabilities they have in order to manage those floating net asset value funds. And that could help reduce some of the … and manage some of the complexity that comes along with it.

Craig Jeffery: So, another area of change, money market funds and the technology required to support those, and as we shift to the third topic, APIs, connecting via open API, we get to bring Paul into the conversation. And, a key part of that element is, Paul, you and I have talked about 2019, as you’ve talked about APIs and open APIs, you defined 2019, or described it as the rise of open banking.

Paul Higdon: Yeah, our view is that APIs are becoming more prominent, and we think 2019 could be the year where we start to see more adoption by the corporate treasury community. But it’s worth taking a step back, because APIs are really just one piece of a bigger technology puzzle. And it’s probably worth reflecting on the fact that we’re pretty much in the middle of what we might call a digital revolution right now. And very interesting to see that technology’s transforming both our personal lives, and our work lives. The APIs are going to play a key part in that. But just one part. So it’s interesting to kind of reflect back how we’ve got to where we are, and if we look back over the past 30 years, I think there are three key events that have happened that mean that we need these APIs.

Paul Higdon: The first one is the increase in computing power. And this has been astounding. If you think back to the 1980s, which was just 30 years ago, the most powerful computer in the world was something called the Cray-2 supercomputer. That cost 34 million dollars. And if we look at the processing power that we all have today, a simple cellphone, like the Apple iPhone X, has got 10 times the processing power of one of those supercomputers, it costs around a thousand dollars, and we get to carry it around in our pockets. So, this really has the ability to transform the way we process information.

Paul Higdon: The second big thing is the rise of the internet. Looking back only 20 years, the internet was really in its infancy. And there were only about 16 million users, worldwide, and that’s less than half a percent of the global population. Fast forward 20 years, by 2017, 4.2 billion of us have ready access to the internet. That’s about 55% of the world’s population. And this is not stopping. This is increasing. We’re all becoming connected, we’ve all got these super fast computers accessible to us.

Paul Higdon: And then the last point, there’s been a real desire to go mobile. Even going back 10 years, the first iPad hadn’t even been launched. Within three years of its launch, it had already superseded sales of desktop computers. So this is a real indicator that we, as a population, we’re demanding immediate access to information, and then gradually, we’re expecting to be able to transact and act upon that information, at any time, from anywhere, on any device. And it’s the APIs that are actually going to facilitate this. Basically, act as the glue to bring these different concepts together, and start delivering value to treasury.

Paul Higdon: I mean, the term open banking is a hot topic. And really, this is an initiative that’s been placed upon the banks to create increased transparency to their customers, potentially allowing increased mobility, so customers can move between banks more effectively. They’re facilitating that through APIs, and that’s where we come to this term, open APIs. And one concrete example that we’ve been working on is the collection of bank balance. So, a number of the banks have produced an API that you can call, that will deliver real time transparency into exactly how much cash you have in one or all of your bank accounts, from a single API call. Gone are the days of relying on prior day files and intraday transactions to know how much cash you’ve got. In this brave new world of APIs, imagine the not too distant future when all of the banks have delivered this capability, then you’ll be able to get real time transparency into exactly how much cash you’ve got, on a global basis.

Craig Jeffery: So the impact is, for treasury, this one example is, real time as opposed to just prior day, just faster … is it an easier to make those connections. What else can be done to leverage this type of technology in treasury, the use of open APIs?

Paul Higdon: Yeah, so it’s a great question, and it’s a hard one to answer because we’re really early days in the adoption of these APIs. The balance example is something that I think is going to impact all treasuries. Another example is, as well as balances, these banks are delivering the ability to see your transactions that are going across your bank accounts in real time, as well. Imagine what impact that could have on treasury. It really has the ability to transform, or revolutionize, many cash management operations. Imagine your treasury management system being completely synchronized, not only with one bank, but with all of your banks, giving you real time balances and a real time view into all of the transactions, being able to reconcile those transactions the moment they come into the system, alert you as a user if there’s an unexpected item so that it can be processed in real time. It completely eliminates the need for end-of-day or start-of-day batch processing that most of the cash management’s departments around the world are performing today.

Craig Jeffery: Okay, that’s excellent. So it’s not just information, it’s alerts, it’s more real time data. So as you think about treasury has long been thirsty for information and it’s been coming in drip formats, it’s been difficult to get, and as we’ve expanded the ability to get that information, it sounds like treasury is going to be getting far more information, now it’s trying to drink from a fire hose, and it can perhaps overwhelm the team that’s getting all of this real time data. So how … Maybe we can segue to the next thing about predictive technology and the application machine learning. How can we handle this deluge of new data and take advantage of it? We can’t do it in the traditional ways, because we’re getting so much more. How can we leverage machine learning to take advantage of this?

Paul Higdon: Yeah, you’re absolutely right. So we’ve solved one problem, and we’ve created another one. We’ve now got all of this real time data, so we need to create systems that are going to help digest and make sense of that data, and turn it into something useful that the treasury team can act upon.

Paul Higdon: And you mentioned machine learning. Artificial intelligence, in general, is something that, again, we’re going to see a bigger uptake, or adoption, in treasury of some of the artificial intelligence techniques. And some of the newer techniques as well, I think. And it’s probably worth clarifying what we mean by artificial intelligence. Classical artificial intelligence has been around for a long time, and by artificial intelligence, all we’re talking about, really, is an artificial system that can perform some complex tasks. So you imagine the kind of logic based systems that have been around since the 1950s, ever since the advent of computing. We’ve been finding applications for that classical artificial intelligence in treasury for many years. Things like automating the creation of cashflow schedules based on financial contract terms. Things like generating the accounting related to all of your financial activity. So your entire portfolio, your treasury system will calculate all of the required journals, including some quite complex business calculations. All of that’s already outsourced to these intelligent systems.

Paul Higdon: So, there are a couple of new advents in this area of artificial intelligence. One is robotic process automation. We’ve heard a lot about that in conferences over the last couple of years. And here we’re talking about new systems that, in fact, try to mimic what humans do. They watch what a human does in terms of its interaction with the various systems that the human used to perform its job, and then they mimic. They play back. They do the same thing. And they allow you to automate processes that require involvement with many different systems.

Paul Higdon: Now, I don’t think, generally, those RPA solutions are mimicking the thought process of a human. Or trying to enhance decision making. They can be integrated into RPA processes, but it’s not really the core of what RPA is about. However, there are other new developments in artificial intelligence, such as machine learning, which do bring something completely new to the table. So, machine learning is a new kind of artificial intelligence that is able to make use of large data sets, and the increased processing power that we talked about with computers. And it involves self-optimizing algorithms that actually are able to identify patterns, and trends, and strategies that maybe the human isn’t able to identify themselves. It’s a new kind of facility that the human treasurer can work hand in hand with to outperform a human on their own.

Craig Jeffery: Maybe you could jump into what makes machine learning so different from the classical AI, as you described it.

Paul Higdon: It … And I think this is why it’s a really hot topic at the moment. There have been some significant breakthroughs in machine learning. And in particular, there’s a technique. This is going to sound a little bit technical, but it’s called deep reinforcement learning. And it’s a progression or a development within machine learning that tries to mimic the way the human brain works in terms of its learning and decision making. And there’s been quite a bit in the news about this recently, and there’s a story that illustrates this very well, related to computers playing chess, and in particular, computers playing chess against each other.

Paul Higdon: Craig, I’m sure you remember back in the nineties when Deep Blue, from IBM, first beat Garry Kasparov, who was the reigning grand chess master at the time. There was a big uproar about computers finally being better at something so complicated as chess than humans. And it was a big achievement. Well, 20 years on, I’d say the great grandchild of the Deep Blue program was something called Stockfish. The program had developed to a stage where the chess community felt that this application could never be beaten by a human being. It was so good at chess, it had access to over 2000 years of human strategy, it’s got to access to a huge number of games that it can search almost instantaneously. So it’s got an unfair advantage against any human. That could’ve been the end of the story, but then we’ve seen this rise of deep reinforcement learning, bringing a new breed of artificial intelligence.

Paul Higdon: And in fact, a new program called AlphaZero was released that was a generalized algorithm that could learn to play any game, not only chess. And it was decided to pit this program against Stockfish. AlphaZero was only given four hours to learn how to play chess, after it had been given the rules. So it played itself about nine million times, and figured out its own strategies without any input from the human strategies. So the two computers were set to battle each other. They played 100 games. 72 of those games were a draw. And then, here, you can guess who won the last 28 games. Sure enough, it was AlphaZero. This program, this algorithm had gone from zero knowledge of chess, to beating the culminative knowledge of everything that we’ve built into programs in the past, by teaching itself.

Paul Higdon: So it’s a very exciting time, as a technology vendor, to now start exploring how we can start taking advantage of similar kinds of algorithms.

Craig Jeffery: Yeah, that’s excellent. That seems like quite a powerful tool. I like the four hours and played itself nine million games of chess. That’s amazing. But obviously, treasury has optimization things in similar regards to game theory, and in ways that have to be optimized, but it’s not a game, treasury, of course. There are, obviously, some algorithms that treasury could use. How can this technology be applied directly into the treasury space that’s being done currently, or you expect to see happen shortly?

Paul Higdon: Treasury is a completely different ballgame to chess. It’s got all sorts of complexities related to uncertainty and complexity in the market, that we definitely don’t have solution yet, that allows such an algorithm to run treasury for you. But what we are doing is exploring various applications of the underlying technology. So for example, we’re already using this deep reinforcement learning in a number of ways, for things like intrusion detection. Our job is to keep your data safe when you use our treasury systems, so we use this technology to monitor access patterns, and make sure that we detect anything unusual, so that we can shut down access if we need to. We use it for things like biometrical authentication. As a user, if you’re logging into your treasury system and you want to approve a high value payment, we need to be certain who you are. So, we can use deep reinforcement learning for things like voice recognition, face recognition, and even behavioral pattern recognition. So how you interact with your cellphone. How you type. Which angle do you use it … you hold it at. To make sure you are who you say you are.

Paul Higdon: And then also things like natural language processing, to make the use of our applications easier. You can type natural language rather than key search terms in order to search through transactions, through menus, through help systems. So all of these are essentially invisible applications of deep learning, but you already start to get the benefit of within our applications.

Craig Jeffery: Paul, I like that. The first two, where you talked about intrusion detection, and bio-metric authentication is really around security. I think that’s interesting because so much of the fraud that criminals are organized, they’re using technology to penetrate systems, to find weaknesses, and to explore, and so they’re making massive use of technology. Now it’s also a technology battle to prevent that, to see what’s anomalous, to see what’s different, to make sure people are who they say they are, and not just a machine that has stolen credentials and is now exploring and finding out what’s going on. You have described and talked about some of your partnership on looking into other ways to use and leverage AI and machine learning. Maybe you can just talk about that.

Paul Higdon: Sure. I can’t share too much of the detail here, but we’re now moving into what I’d say is our second phase of trying to find applications that are much more visible to the treasury team. And to do this, we’ve actually entered into a partnership with one of the leading technical universities in Europe, who have specialisms in artificial intelligence. And we’re sponsoring a research program there, where we’ve worked with the teams to identify some candidates for what we think could potentially be high impact areas of treasury management that are good candidates for applying machine learning to.

Paul Higdon: For example, actually, I can tell you that the one that came out top of the list is cash forecasting. This is something that has proved difficult for treasuries around the world to do accurately. We’re currently exploring with the university there, which are the most appropriate algorithms for us to employ to look at historical cash management information, and use that, along with forecasts from internal entities within the business, to provide more accurate forecasting capabilities going forward.And there are a few other applications that we’re exploring, and we anticipate rolling these into a number of our applications throughout 2019 and onwards.

Paul Higdon: So, yeah, we expect … We’re obviously investing here, so we expect machine learning to play a significant role in the future of treasury managements. And we’re investing now, not only in the technology to build the algorithms, but also starting to think about how we would build the learning data sets that the algorithms need to become really effective across the community of all of our corporate customers.

Craig Jeffery: And just like the chess example of playing nine million games, there’s a lot of data needed for that learning environment. And maybe we can just shift to the last area and bring Mike back in on treasury communities. ION has been talking about communities and what that means for treasury, both in terms of sharing best practices, leading practices, and data, that can provide insights. I want to just hear some of your thinking on this from a technology and/or data perspective, Mike.

Mike Kolman: I think almost all of the topics, if not all of the topics we covered today, likely that will be covered on this podcast series, really have an element of community. It’s not just about our organizations. It’s really about our industries, our practices. And I think we start to see that more and more, and becoming more and more of an integral part of really what we do.

Mike Kolman: And so, as Paul mentioned, with machine learning, for example, our greatest opportunity for new insights requires the ability to learn and build off of large data sets. And then share those insights, and share that learning to inform the community as a whole. There is an element of sharing that exists today, and when we think about community for short, and I think our natural inclination draws us to our peers. I might be drawn to other people in treasury who have a similar role as the one that I have. Or, I might be drawn to others who use a similar technology that I use. And I think this is really community in the traditional sense. These communities, in this sense, play an important role. And they will continue to play an important role in advisement, in validation, in promoting shared interests. Is there a better way to do what I’m doing? How will I ever get my arms around understanding this enormous exposure to Libor? These communities, in the traditional sense, can certainly be therapeutic, and anxiety reducing, for sure.

Mike Kolman: However, when we start to think about the opportunities that new technology brings to us, and we think about communities really more as a source of innovation, in some ways, we can actually find inspiration from non-peers, and understanding their experiences. And so, for example, when I go … when any of us go do shopping on Amazon, Amazon knows what I want to buy before I even know I want to buy it. And so, another example that I recently had at the beginning of this football season, when I did my fantasy draft, it was the first I ever did a fantasy game, but I didn’t really … I realized, I didn’t have to do anything, because I see the best players that are available to me. I didn’t have to know anything about the players. All of the metrics are all being run in the background. And it’s providing advice to me on what I should do.

Mike Kolman: When we think about treasury, I don’t think there’s a single company that can get to that level of insight that’s being provided in the fantasy example, or by Amazon, for example. No one company can get to that insight alone. And so it really does require larger amounts of users’ volume history to learn, and experience, and be able to identify some really interesting insights that will really transform the way that we work today. And it really isn’t that farfetched to expect that in treasury, the decisions that are being made are fed to us as recommendations from our technology. And it informs the activity really across the entire community. And so as we look into 2019 and beyond, we expect more and more that community will become a greater asset to the whole corporate treasury landscape.

Craig Jeffery: This is fascinating. Thank you for that discussion on treasury communities and data, and wrapping that up. And this concludes this episode of the 2019 Outlook, 2019 Treasury Technology Outlook. Mike and Paul, thank you for talking through these ideas on The Treasury Update Podcast.

Mike Kolman: Thanks for having us.

 

Maximizing the Speed of Treasury

 

How can treasurers maximize the speed of treasury in 2019 and beyond? Craig Jeffery interviews Vice President and Chief Operating Officer Tom Leitch of TreasuryXpress on new methodologies and treasury systems that will increase speed dramatically, improve efficiencies, and scalability.  Listen in as they discuss real-life examples on how treasures can remove friction and accelerate the speed of treasury.

Tom Leitch

VP of Business Development

Treasury Xpress

Global FX Outlook

 

On this episode, Craig Jeffery sits down with David Pierce, Managing Director of Global Hedging Products at GPS Capital Markets, who has appeared on CNBC to discuss the impact of foreign exchange exposures on the US economy and worldwide. Listen in as they share valuable insights into macro-trends and developments taking place for the coming year.

David Pierce

Managing Director of Global Hedging Products

GPS Capital Markets

Episode Transcription - Global FX Outlook (GPS Capital Markets)

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Intro: On this episode of the 2019 Outlook series, Crag Jeffery sits down with David Pierce, Managing Director of Global Hedging Products at GPS Capital Markets, to discuss the impact of foreign exchange exposures on the US economy and worldwide. Listen in as they share viable insights into the macro trends and developments taking place for the coming year.

Craig Jeffery: I’m here with David Pierce from GPS, and let me give you a little background about GPS and David Pierce and then I’ll welcome him to the podcast.

Craig Jeffery: GPS is the largest FX broker in the US, they’re licensed in the US, the European Union, they also have offices in Australia. David Pierce heads their Global Hedging Products team and is their lead economist, he’s appeared on CNBC and he has over 30 years of FX experience. David, welcome to the podcast.

David Pierce: Thank you so much. Glad to be here.

Craig Jeffery: So, David, let’s begin, as we look forward, let’s start by looking back on 2018 maybe you could step through and review some of the biggest items that have impacted FX, particularly making larger FX movements, what are they and how we should we think about those?

David Pierce: I think that’s it’s probably best to start with the tariff issue that we’ve had going on from a political standpoint here in the United States and how that has impacted countries around the world.

David Pierce: Starting with China, the tariffs that Trump has put on goods with China have made a significant difference in the currency exchange rates between the United States and China. The reason for that is the Chinese, the way they have retaliated against these trade tariffs, has been to devalue their currency. They’ve been able to value their currency over 8% in a response to these tariffs. The problem that China has got, and this bleeds over into the rest of Asia, is that the United States is a huge importer of products. For instance, the United States only exports about $130 billion a year to China, but their imports are about 500 billion, so almost four times as much, this gives the United States much more control and power to put tariffs on Chinese goods than they have to put tariffs on US goods. They recognize this and because of that they have chosen to devalue their currency in addition to the retaliatory tariffs that they have placed on US goods to preserve their mark position and the amount of product that they are selling internationally, and that has brought implications throughout all of Asia because China is the second largest economy in the world and it becomes extremely impactful.

David Pierce: The second thing we need to look at is let’s talk about what’s happening in Europe and let’s talk specifically about tariffs to begin with, then we’ll get to other things like Brexit.

Craig Jeffery: Before we jump too much into Europe let’s finish up with the renminbi if I could just ask a question on that, how does that fluctuate the price? I know it’s been more than 5% but what’s going on with the USD renminbi rates?

David Pierce: Yeah. The exchange rate, the dollar versus the renminbi, the US dollar has strengthened against the renminbi, almost 8% since April, and it doesn’t sound horrible that the US dollar is stronger but the Chinese government does not allow the Chinese renminbi to freely float in the market place. Meaning they really control and manage what exchange rates their currency is going to be exchanged at versus other currencies, so it is a managed currency. It’s not freely floating. What they have done is they have weakened their currency to make it so that it is less expensive for us in America to buy products from China. An 8% movement doesn’t completely counteract the tariffs that has gone on but it goes a long way. When you look at the tariffs that they have put on US goods combined with the 8% depreciation in the Chinese renminbi, it makes a huge impact.

Craig Jeffery: Excellent. So that’s great information. Moving from China and the far east I think the next area you wanted to cover was Europe, and I know you’re talking about trade tariffs as well as … Well, we talked about Brexit before this episode but maybe you’d cover Europe.

David Pierce: Yeah, let’s talk about trade and tariffs where it relates to Europe right now because that’s also really big news because, as we all know, Trump has been on a mission to try and make things, in his words, equal, and with Europe is a really difficult dynamic right now. I think that the best way to describe this is when Jean-Claude Juncker was over visiting with Trump a few months ago, they were talking specifically about automobiles and the tariffs on automobiles, the comment came up that any US cars that are exported into the European Union had a 12% tariff imposed on them by the European Union. Counter to that, any cars that came into the United States from the European Union only had a 2% tariff. Well, Trump said, why don’t we both go to zero, and Junker said, no we can’t do that, and he says, well let’s got 25%, and he said, no we can’t do that, and then the explanation was really interesting.

David Pierce: He said that we can’t do either one because if we lower the tariffs on US cars coming into Europe, because the dollar volume of automobiles coming into Europe is so high and with the 12% tariff the European Union specifically needs that money to run their government and without that money they will not be able to manage running their government because any tariffs on vehicles and any product that is imported into the EU, none of that money goes to the car manufacturers and people that are in the specific industries, all that money goes directly to the governments.

David Pierce: Counter to that, he said that if the United States raised tariffs on European cars, so your Mercedes, and your BMWs, and Portias, and FIATs and so forth, that that would devastate the European economy because it would reduce the amount of cars that the Europeans were able to sell into the United States. And given the very tenuous nature of the European economy right now they could not afford to either reduce the tariffs that they charge on American products or allow the United States to increase tariffs that they currently have on European products because it would be devastating to the European economy.

David Pierce: Understanding that right now in Europe they are in a negative interest rate situation because they’re trying so hard to stimulate their economy because they are struggling, and if you don’t understand what a negative interest rate is that means if you take $10,000, deposit it in your bank, your bank is actually going to charge you interests for keeping those funds sitting in a bank account. That’s what negative interest is. Same thing goes along with borrowing, you can borrow funds there at very, very, very low rates, and they have done that to try to stimulate the economy in Europe. So from a tariff standpoint, Europe is in a really tough situation.

Craig Jeffery: Now, as we continue to look back on some of the big movements in FX maybe you could cover some of the other movers, whether it’s related to Brexit, North American trading, maybe you could talk about a couple of those and then we’ll focus fully on 2019.

David Pierce: Let me talk a little bit about what’s been going on in some of the other countries in the world. The US dollar has been strong against almost every country in the world. There’s a few currencies that have done pretty well, one of the main currencies that has strengthened this year is the Japanese yen. It has strengthened about 3 1/2% against the US dollar over the last year. The Japanese economy is finally starting to perform, and this is really significant because they’ve been in a really under-performing economy for over 20 years. So to see the Japanese yen finally starting to strengthen, finally starting to do well, and the Japanese economy coming around is really significant, especially compared to some of their neighbors like China and South Korea that has had more struggles than Japan has.

David Pierce: If we look at the US dollar against the euro, the US dollar strengthened 7.4% this year against the euro, that’s in 2018, and so the euro continues to depreciate against the US dollar as the US economy is stronger than the European Union and they still continue to struggle throughout the EU. Neighboring the European Union is the British pound, and the British pound has also weakened, 6.7% against the US dollar, a lot of that is on the backs of Brexit and general weakness in the economy in Europe.

Craig Jeffery: Why would the US dollar strengthen more significantly against the euro than the GBP if Brexit was having an impact?

David Pierce: The economy in the United Kingdom is much, much stronger than in the mainland European continent, and so if we took Brexit out of the equation I would think that the British pound would have been flat to maybe even a little bit stronger against the US dollar. But Brexit has really been weighing against the pound and it has been pulling it down because people are concerned that if Brexit goes through they’re going to have more economic difficulties in England than they currently because it’s going to be more difficult for them to trade with some of their European counterparts.

Craig Jeffery: Interesting. Okay. Makes sense.

David Pierce: Moving on to some of the other countries around the world, Canada, the US dollar has strengthened 7% against the Canadian dollar over the last year. This is really interesting because traditionally the US dollar and Canadian dollar exchange rates have really followed the commodity markets, and when we look at gold, and silver, and oil, the Canadian economy has really depended on those commodities and the US dollar kind of follows along that line between the price of commodities versus the exchange rate between the Canadian dollar. So we’ve seen Canada weakened about 7%. Some of that also has been and the backs of the North American Free Trade Agreement that has been up in the air and that Trump has renegotiated, and since they have come to an agreement we’ve actually seen a little bit of rebound in the Canadian dollar and a little more strengthening, so that is actually looking a little better than it did earlier in the year.

David Pierce: The next one to talk a little bit about is the Mexican peso. The Mexican peso has had a ton of volatility this year. It has moved 16 1/2 % this year. That being said, where we started out the year and where we are right now, we’re only about 2% different. So the Mexican peso has weakened a little bit this year but it has had a tremendous amount of volatility. The volatility that we’ve seen in Mexico has been really surrounding the elections that they’ve had in mexico and we saw a significant weakness with the presidential election down in Mexico, but their economy has been doing fairly well and so once all the rhetoric from the election died down we’ve actually seen the Mexican peso rebound quite a bit against the US dollar.

David Pierce: On a global basis, if we look at what’s called the US dollar index where we compare the dollar against all the countries as a basket across the globe, the US dollar has strengthened 8% on a global basis. And if we look at the world economy, pretty much the US economy is doing very well compared to any other economy in the world. And this might be a good time to talk about NAFTA and some of the revisions of that because the US economy is extremely reliant on what goes on in both Canada and Mexico, and I think that a lot of people don’t realize how interdependent those three markets are with one another. If we look at the United States’ top trading partners, China is number one, followed by Canada and Mexico, so Canada and Mexico are the second and third largest trading partners of the United States. So Trump renegotiating trade terms with both of those countries makes a significant impact, not only on the US, but also Canada and Mexico, because there really is a lot of synergy.

Craig Jeffery: Let’s try to look forward a little bit, into 2019. There are definitely a number of macro economic shifts taking place maybe you can comment on some of those in the context of investment decisions or risk management decisions that go on. Why don’t we start with the Brexit, is there going to be a resolution on that?

David Pierce: Yeah. I mean, nobody can go anywhere without hearing the word Brexit right now because it seems like it’s the top of the news in everything that you see. Every report has got something about Brexit. As you know, the last few days have been really interesting because Theresa May’s proposal for Brexit was shut down in Parliament and it was voted against by over 200 votes, and that is the largest loss of any major vote that has ever happened in the British Parliament. So it was soundly defeated in the British Parliament. A couple days after that they actually had a no-confidence vote for Theresa May, whether or not they wanted to remove her from office and have another general election in the UK, and she won that by just 20 votes so she is going to continue as Prime Minister for now. The problem is Brexit is supposed to happen in just a few weeks, and they do not have a plan in place. What we really need to try to understand is what are the implications of either going forward with no deal, or trying to postpone the implementation of Brexit, or what are the odds of them being able to renegotiate a new deal.

David Pierce: So let me just talk about a couple of those different options. Number one, what happens if they go forward with no deal? Well, the biggest implication really on this has to do with Northern Ireland and Ireland because it’s one continent … Well, not a continent but an island, and there is no real border there, there’s a lot of back and forth travel, and they’re fairly homogenous people, and there has not been any agreement on how they’re going to deal with the movement of people and goods in Ireland to Northern Ireland, and that seems to be the biggest sticking point in all of the Brexit negotiations. And what happens if they don’t have a deal? What are they going to do? There is no checkpoints. There’s nothing. So most likely there’s going to be pre-movement of trade back and forth even if we go through with no deal.

David Pierce: The next thing that is a real big point of contention is how much the UK is going to pay in penalty, so to speak, to leave the European Union? The European Union has kind of been taking a hard line and basically wants a pound of flesh because the UK is leaving and they’re trying to demand huge amounts of money for them to leave in return for continuing to be part of the European Union as it comes to trade. If they go forward with a no deal, the United Kingdom will still be able to trade with the European Union, but it will be under IMF regulations rather than negotiated trade within the EU. So they will have to worry a lot more customs duties and being able to get everything certified. It’s going to be more work for anybody that’s going to be importing or exporting anything within the European Union. So those are the big implications going forward. And so UK companies could have some significant impact, and especially exports.

David Pierce: What happens if they postpone this for another 8, 10, 12 months, kick the can down the road, so to speak? That just means that there’s going to be more uncertainty in the market. I think that it’s going to be more of the same and we’ll not see a ton of implications right now and things will just go along as they currently are.

David Pierce: The third option really is if they’re able to put together a last minute deal with the European Union and agree to a new plan, which Theresa May is trying to put together right now. I think the odds of that are very, very low. I think that the odds of a no deal seem to be the best right now, that that will happen, followed closely behind with them extending the time that it’s going to take them to leave the European Union. So either one of those two are the most likely result of this. But anyway shape or form you look at it, there’s going to be more uncertainty in the market place.

Craig Jeffery: Interesting. So let’s move across the Atlantic to the US, let’s talk about tax reform impacts, fed funds, I know you had mentioned a couple items there, so I wanted to hear what you thought about tax reform. What are the things that are impacting the economy, exposure to FX, even if it’s just related to tax reform?

David Pierce: Yeah. From a tax reform standpoint, we’ve had a significant reduction in taxes here in the United States and we’ve seen two things that I think are significant as part of that, number one is that we have seen a lot of direct foreign investment coming into the United States. It’s coming in in a way that we have not seen before because taxes are significantly lowered here and we see a struggling European economy, we’re seeing a lot of big chunks of funds coming in and we see a lot of family offices and private individuals sending 50, 100, 200 million dollar chunks of funds into the United States to invest in different ventures. The rate of this has picked up dramatically from anything we have seen in the past, so that’s one thing that I think has been a big change.

David Pierce: The second thing that companies need to think about from a financial and economic management standpoint is they have changed the way that leases are managed from an accounting standpoint. It used to be that your leases were an off-balance sheet item and they have changed it so that leases are now an on-balance sheet item. So if you’ve got leases of building, plants, equipment, anything like that that is denominated in a foreign currency, that is not going to have to be revalued on a monthly basis where you are going to have FX gains and losses to your financial statement if you’re not doing anything to manage the exposure of those leases. And in the past, most companies completely ignored those, did no hedging because it was an off-balance sheet item, did not impact their financials from an FX gain or loss standpoint, or income statement standpoint, so that changes something that I know that we have a lot of clients right now that are really, really struggling with that because they have to change the way they’re looking at all of their leases and they got into these leases specifically so that they were off their balance sheet, and now it is being very impactful to them.

Craig Jeffery: Now it’s back on.

David Pierce: Yeah, it is. You asked about fed funds and how that can be impactful to us, there is a really interesting correlation between long and short term interest rates and the St. Louis Federal Reserve has done this big study going back about 50 years, and what they look at is short term versus long term interest rates and they take the 10-year treasury versus the two-year treasury, and when the long term interest rates changed so that they are lower than short term interest rates, shortly following that, there has always been a recession. And if you look at the graph that they provide, there has been five instances of a recession happening and right now we are getting close to that line where the long term interest rates are almost the same as short term interest rates, and as the fed continues to raise short term interest rates we’re in danger of those short term interest rates exceeding the long term interest rates, and typically between one year and 18 months after that happens there is always a recession in the market. So that’s one of the things that we need to just watch, think about, worry about, and be prepared for.

David Pierce: And from a foreign exchange standpoint, when we look at interest rates, we are helping clients that are hedging and managing their exposure out into the future, and so we’re always watching where these interest rates are because they impact the price of the derivatives that we use for helping people hedge. But I think that that’s something that we need to watch for going forward because we’re kind of getting close to that level where we could be having a recession in 18 months, 2 years, if we see some additional fed funds rate increases, which we’re expecting two more of this year by the way.

Craig Jeffery: We look to the fed not necessarily being a complete autopilot with the rate raises and they made some noises in December about maybe less-

David Pierce: Yeah, they had originally planned to have three rate increases this year and they have come out and announced that they are now planning on having two rate increase. So they have backed off from there they were a few months ago but we’re still at the point we’re expecting a couple more rate increases this year.

Craig Jeffery: Maybe you can comment on this as well, I mean with moving from quantitative easing to quantitative tightening where they’ve been dumping about 50 billion back into the market every month, is that likely to continue and is that having an impact as well on the different rates we’re seeing?

David Pierce: Yeah, I mean anytime you change the money flow we’re going to see an impact on rates, we’re going to see on impact on people’s appetite for going into new business, expanding their current businesses, and as we see higher interest rates are making it tougher for people to go out and borrow funds, because it’s going to be more expensive … So yeah, it definitely impacts the economy. What we don’t want to see is the economy to slow down as much as the rest of the world. It’s really kind of a juggling act where you want to a strong economy, you don’t want it to be too strong, and I think that we’re almost a that tipping point right now where we have accelerated the economy and then we’re slowing it down by increasing interest rates and we’re almost at the tipping point where if we raise rates much more than we currently have then we’re going to turn the economy backwards and we’re going to be slowing the economy back down again, and I don’t think anybody really wants that to happen.

Craig Jeffery: Interesting, a number of factors moving in different directions. So this is a 2019 outlook podcast discussion and the audience is increasingly global as we’re into our start of our second six months, maybe you can give us some projections on currency rates. Where do you see them moving and what are some any additional influencers on those rates that you foresee in this coming year?

David Pierce: Well, that’s a very general question because we’ve got a lot of different currencies out there and a lot different rates-

Craig Jeffery: Okay. Maybe the majors.

David Pierce: Yeah. Let me address than on a region by region or currency by currency basis, I think that makes a lot to sense. When we look at currency movements there’s really two main things that drive it, economic activity and speculation. And economic activity is just the idea of somebody in Germany making cars and shipping them to the United States, and the more cars Germany ships to the United States that means the more US companies are going to have to sell US dollars and buy euros which would tend to strengthen the euro, and that’s the main driver behind changes in exchange rates is really economic activity. So if we look at where economies are going to go over the next year we really expect the European economy to not grow. We’re expecting it to be flat and even negative growth, and so we’re not expecting a lot of out of the euro this year. It’ll go up and down a little bit, but we’re expecting it to be flat to weakening against the US dollar. Same with the accompanying countries in the European area, the pound and the Swiss franc.

David Pierce: In Asia, if we look at China, I think that we’re going to have a resolution of the trade war with China, and if that happens we should expect to see the Chinese renminbi strengthen again versus US dollar, and I’m expecting that to be concluded in the next few months. I cannot imagine that China would want to go into a prolonged trade war with the US just because, like I mentioned earlier, we have four times as many imports as they do and so they are the ones that would be on the big losing end of this. And so we have way more ammunition in the gun, so to speak, so they really need to get this solved. And once we come to a resolution on the tariffs with China, they will allow their currency to strengthen once again. So I think from the Chinese standpoint we should a strengthening in their currency. Same thing with the Japanese yen, the Japanese economy is doing fairly well, expect to see that strengthen some.

David Pierce: One of the interesting currencies that we haven’t talked about yet is the Australian dollar, and the Australian dollar has been weakening this last year and some of that has to do with what’s been going on in China. As China struggles, Australia struggles because they provide a ton of food and raw materials to the Chinese economy, and as the Chinese economy has had some struggles this past year because a lot of it is due to the tariffs with the United States, it has really impacted the economy in Australia. So as we see the trade war ending with China I expect to see the Australian dollar rebound and strengthen against the US dollar once again.

David Pierce: Then if we look north and south of United States, Mexico and Canada, the Canadian dollar I think that is a little bit too weak right now and I expect that now we’ve got trade issues solved with them and if we see a strengthening in the price of gold and silver and oil, we should see a strengthening of the Canadian dollar this year. The Mexican peso, really interesting, it traditionally has been kind of a one-way street against the US dollar, the last four years it’s depreciated 42% against the US dollar and it usually does that on a pretty regular basis, but following the election we saw a significant amount of strengthening in the Mexican peso so that one is kind of up in the air. We really need to see what happens with the change in administration down there, and I could see the Mexican peso being more flat against the US dollar than it has in the past, which for them would be a real big win. So that’s where we’re seeing currencies go in general around the world.

Craig Jeffery: Okay. I’m not sure we covered the pound this next year. You did talk a little bit about it with Brexit if there’s resolution or not, what’s your outlook on the sterling?

David Pierce: Years. With the British pound … So goes Brexit so goes the British pound. And it’s my personal opinion that if Brexit goes through, especially if it goes through with no deal, we will see an immediate devaluation of the British pound. I don’t think it will be dramatic but I think that it’ll be somewhere in the 8 to 10% range which is a good move. But I expect from that point on that the British pound is going to rebound because no matter what anyone says their economy is still doing very well over there, business is good, and businesses seem to be growing in the UK, and I think that once that knee-jerk reaction is done we’re going to see a continued rebound and strengthening of the British pound. I really don’t expect that a year from now we’re going to see the exchange rates on the pound versus the dollar much worse than they are now, and if anything I could see a a little bit stronger pound at the end of the year if all goes well for them.

Craig Jeffery: You talked about the movement of flow of funds, I don’t know if there’s anything else that you wanted to mention about that in terms of access to capital, rates that might be available for investments in the US, for example, versus Europe.

David Pierce: We look at currency rates … One rule of thumb is you always chase the higher interest rates, and so the country with the higher interest rate is going to be the stronger currency and it will continue to do that. The reason being, people are always looking for a better return on their funds. So if you’re somebody sitting in the European Union and you’ve got 50 million euros and you stick it in a bank account and your bank says, oh that’s great, thank you for the 50 million euros we’re going to charge you half a percent a year to keep your funds. Your money is losing every single day you’ve got it in there. So what a lot of people are going to do is say, well, guess what, I can send it to the US and I can get a return there in my funds, it might not be tremendous but I could get 3 or 4%, so I’m going to send those funds to the US, invest them over there. And they may invest them in treasuries, or just interest bearing funds, but most likely they’re going to look for a greater return of funds than just 2, or 3, or, 4%. And in an economy that’s growing that’s much simpler to do than in an economy that is shrinking.

David Pierce: So that’s one of the things that we always see is … Well, in general, if your interest rates go up there tends to be more demand for your currency.

David Pierce: Now, there’s obviously exceptions to the rule when we get to some of the South American countries that have extremely high interest rates or hyper inflation, that kind of breaks the rule of thumb because the amount of inflation they have going on there really overruns the value of their currency going up, and Mexico is an example. They’ve got significantly higher interest rates than the United States, but yet their currency continues to devalue against the US.

Craig Jeffery: So, as we wrap up, David, what do you say to your clients or others about the opportunities or concerns that they should be monitoring throughout 2019? You’ve touched on a few of them, maybe you could talk about any course of action or advice, what should they be monitoring, when should they act, maybe just give a few pointers.

David Pierce: Well, I think people should always act now. If you’ve got exposure you need to look at it and you need to be proactive. A lot of people sit back and say, well, I’ve got exposure, I’m underwater, I’m just going to sit back and wait until it goes my way. Well, that’s like flipping a coin, if you wait until you flip a coin until whether heads or trials you choose comes up, that’s not really an investment strategy, that’s not really a business strategy, that’s gambling. And I always try to encourage people to look at any exposure they have now or any exposure they expect to have in the future, and really be proactive in managing that.

David Pierce: One thing that we have seen more and more over the last couple years is people willing to look at alternative products and alternative ways to manage their risk. It used to be that a forward contract was the only hedging option that people would do in the United States. It’s more and more common for people to say, you know what, I know I’ve got exposure, I know I’m going to have $100 million in risk over the next 12 months, I’m not sure quite sure when it’s going to be, but I want to protect by downside.

David Pierce: That being said, I’m a proactive CFO, I’m a proactive treasurer, I want to do what’s best for my company, and so I am also willing to look at some products that give me some rate improvement and that have some rate upside on it and ways to get a better rate in the market place. And we’re seeing more and more companies asking and wanting to look at products like that so that they can actually take advantage of some swings, upside in the market, especially given all the volatility we have, and with the volatility we’ve seen this last year a lot of companies have really come out on the losing end of that because they have not been really proactive. And that’s what we try to do is help companies put together a plan to look at their exposure, identify what that exposure is, when it’s going to occur, and look at a half a dozen different ways that we could manage that exposure and try to put together a plan that matches their risk profile and help them eliminate any downside, but hopefully get a little bit of upside in the market as well.

Craig Jeffery: That’s not speculative like you had mentioned before, just waiting, it’s looking to protect your range but giving yourself some leeway if it moves in a particular direction.

David Pierce: Yeah, and I’ll give you an example. I mean, we had a client that sold off one of their businesses in Europe, and from the time that they started to sell to the time that they completed the sale was a number of months, it was six or eight moths, and during that time frame they also changed treasury staff and CFO, and the previous treasury staff had done nothing to hedge this sale. They knew it was going to happen, they knew when it was going to happen, but they hadn’t got the funds yet. But by the time they got the funds, and this was a large amount of money, the market had moved 6 or 7% against them. They had been sitting on these funds for months and months because they said they couldn’t afford to bring the funds back, even thought they wanted the funds back in the United States, because they were at such at discount at what they were supposed to have got for the company they sold and so they were just sitting there on the funds.

David Pierce: Well, if you’re not doing anything to protect your downside there’s some products out there where you can say, all right, I’m not protecting my downside but if the market moves one way or another I can get some upside from the market greater than what the market rates are, there are some leverage products, that way there’s … The market might move 2% in their direction, but the market moves 2% in their direction you can get 6% upside, and that’s a way that they could leverage their exposure so that they could actually get the rate that they were looking for in the market place. And at the time, they weren’t doing anything anyway, so if they put something, a revenue enhancement strategy in place, at least they’re doing something to try to get a better rate, and if the market goes that direction then it’s a lot easier for them to get the funds back.

Craig Jeffery: Excellent. Thank you, David. I appreciate you joining me on The Treasury Update Podcast with this 2019 outlook.

David Pierce: Thank you so much. I appreciate being here.