Category: Finance

Oil, a three-letter word that embodies the most important source of energy since the 1950s, the lifeblood of modern societies. As the main energy supply, this commodity reshaped not only the power industry, but also how we live, supplying 40% of the world’s energy demand. Therefore, oil continues to survive the constant attempts to shift energy consumption into more sustainable alternatives based on renewable sources, remaining the most-traded non-financial commodity worldwide. The fact that, nowadays, one cannot imagine a world without crude oil, and its inexistence would lead to a screeching slump in modern societies, increases its value, emphasizing its prominence in the global economy.

The United States, Russia and Saudi Arabia arise as crude oil’s largest producers and, in 2019, jointly produced approximately 33 million barrels per day, 54% of total world production. According to IBISWorld, a leading Business Intelligence company, the oil and gas sector’s revenues amounted to approximately $3.3 trillion last year, and with a 2019 Global GDP of around $87 trillion, the oil and gas drilling sector by itself represents around 3,8% of the world economy. It is evident that the 3 main players in this complex industry compete for the monopoly of one the most profitable markets, but one cannot enter this game without caution, since the oil’s biggest sharks will be ready to counter-attack.

With the world markets slowing down due to the most recent crisis caused by the coronavirus pandemic, demand on crude oil has decreased drastically, as isolation measures have tightened around the world.

The members of the Organization of the Petroleum Exporting Countries (OPEC) and the invited country Russia, gathered in a meeting concerning the market demand on the industry after the virus situation. Russia has been allied with Saudi Arabia and the organization since 2016 with the aim to balance its production levels with other countries and keep prices relatively stable.

In this meeting, Saudi Arabia positioned itself and suggested cutting production levels in order to hedge price decreases during these times. However, Putin’s nation was against the proposed measure as they believed it was too early to cut production, the organization failed to reach an agreement between the parties involved, effectively ending the partnership. Some insist that the country is availing oneself of the Asian demand to increase its market share, others agree that it wants to keep prices low to fight the American shale oil industry, which has been growing in the past years. One thing is certain, Russia is indeed worried about its market share and believes that at the moment it is better to be against the Saudis than opting to cooperate. Saudi Arabia counterstroke, announcing they would increase their production to its highest, almost 13 million barrels per day, as well as price discounts in Europe and the United States.

On the 8th of March, the prices started to tumble and the next day they plummeted more than 30%, the worst loss since 1991, and the Russian currency depreciated to its lowest since 2016. For now, the Saudi-Russian alliance is paused, and the war has begun. The Saudis believe they will be able to sustain profits, as their production costs are very low, while Russia claims the ability to sustain prices between 25$ and 30$ for several years due to its National Wealth Fund. Nevertheless, these countries will now experience a thinner margin, despite gaining some revenues alongside customers. From a game theory perspective, we are assisting a prisoner’s dilemma situation where either party may end up hurt after this move since market share will not necessarily be gained and cooperation would better position themselves.

On the 2nd April, Donald Trump claimed that a deal was expected to be reached soon and that production cuts were already in order after affirming that he talked with the leaders of both countries. This prompted a one-day rally in oil futures of 10%, but neither countries committed to supply cuts and the Russian Government denied the claims made by the US President.

On Sunday, April 5th, Saudi Arabia, Russia and other giant oil producers from OPEC made progress in reaching a deal to stem oil prices, despite the difficulty in arranging a meeting and the continuous exchange of accusations between the two leaders. This deal would also involve the US, as they became the biggest oil producer of the last years since the shale revolution and have a great impact on this industry. Together, the members would be proposed to cut their oil production by 10%, but Donald Trump has shown little willingness to do so. The US has even threatened the use of sanctions and tariffs to push the two countries to solve the conflict.

Energy companies are suffering the most from oil wars and this may have a damaging effect on the credit markets as well, since they have been very active in the bond market in the past decade and investors were always keen to lend more and more. This borrowing was done using junk-rated bonds and it is remarked that these companies account for 11 per cent of the US high-yield market. Being rated BB or lower, these issuers are at higher risks of default and the current oil war aligned with a decreasing global demand may cause further downgrades and raise the costs of borrowing. With such a heavy representation on the junk bond market, this shock may not stop at low-rated debt and even impact “safer” debt.

Investors reacted as they have been adjusting to the coronavirus outbreak and shifted funds for the usual safe havens. On the 9th March, the sharp oil price drop prompted a decrease of 7% in the S&P 500 in the first minutes of trade. This sell-off was accompanied by a raise in the price of gold and related ETFs and an increase in the purchase of US Treasury Bonds, represented by a decrease in the US Treasury yields.

At this stage it is quite unclear to predict any short-term agreement between both parties, however, what is clear is that current prices are bad for producers whilst being well received for consumers. What this means is that, in theory, oil importing countries will benefit from this price decrease, considering that one of their main raw materials used, became drastically cheaper. However, this benefit will obviously not be maximized due to all constraints being imposed by governments worldwide during the COVID-19 pandemic, which, ultimately will make this decrease in prices a small tool to respond to the economic impact caused by the viral disease. Furthermore, not everything is bright for importing countries. Let’s take Portugal as an example, which has Galp, which refines imported Brent oil from Brazil and Angola before selling the final good to retailers, as one of its largest companies. Galp had set an average break-even price of 25 € and is still able to sell at current prices, however, as seen in the last few weeks, its price has been right around that value, even reaching the 21€ quotation. As seen, Portugal is not a producer nor an exporter of the raw material, yet, by having companies in its manufacturing chain like Galp, is still exposed to this war that influences prices worldwide and can lead to lay-offs and even shutdowns.

On the other hand, we have the petroleum exporting countries being harmed by not only the influx of supply as the decrease in demand. Some are being forced to decrease prices while also increasing production, to not lose their market share, while others are considering a step-back in production until prices begin to rise. One example being the case of the US which produces, in mass, Shale Oil, which is more expensive to produce. Also, countries that cannot step-back due to an already unstable financial situation as Venezuela, Ecuador and others third-world countries are being dragged into a fight they just cannot handle, especially considering that, unlike Russia, they do not hold a meaningful foreign exchange reserve to back up these abnormal losses, so, debt defaults are beginning to look a reality.

The markets and investors are not happy having to deal with an oil war and a virus outbreak and, if Russia and Saudi Arabia take long to solve this conflict, Governments and Central Banks may not be able to save world economy.

Sources: CNBC, Investopedia, TIME, Bloomberg, Financial Times, Vox, ABC news

Despite the world’s biggest central banks intentions to deliver monetary policy in order to soften COVID-19’s impact on the economy, markets continue to fall sharply in an irrational manner. On the last week of February, the major financial indexes showed startling results registering their biggest fall since 2008, with the S&P 500 dropping 11%, its worst weekly decline since the financial crisis,  the Dow Jones Industrial Average crashing 12.4% and the PSI-20, the main Portuguese index, registering its worst result since Brexit.

How are investors reacting?

A few stocks managed to escape the sentiment of fear by investors. Evidently biotech stocks, particularly the ones involved with the production of vaccines and antivirals, were one of the main class of stocks that rose in recent weeks. A particular example was Zoom, as investors are already pricing an expected period in which people will be forced to work from home and must use systems like the ones this company develops.

Investors quickly ran to the “safest” asset in the financial markets with US Government Bonds surging and dropping the 10-year US Treasury yields below 1%, an all-time low, also as a result of the interest rates cut by the Fed.

The yen is another traditional safe harbour being perceived as one of the most stable currencies amid market uncertainty and, at the time this article is being written, stands at 108.20 yen a dollar. Gold reached a seven-year high last week with investors using the precious metal as a haven from the meltdown in Wall Street. But, in these last few days, gold’s price plummeted with the biggest one-day decline since 2013. Gold dropped 4.5% on the 28th February as investors are selling it to cover margin calls as needs for cash arise due to the sell-off in stocks and fear is rising that China’s demand for gold is severely weakening.

However, ETF investors seem to be the exception in a week of pure panic in Wall Street. When we take a closer look at ETFs linked with the stock market indexes, we observe that the players that shifted higher amounts of cash from SPY have been institutional investors that are being faced with liquidity concerns, it was not a panic move. Another trend is the outflows from funds related to Japan who are in the frontline of the virus and shifts to European markets, for example. At the same time, with the decrease of interest rates and the continuous inversion of the yield curve, investors dumped financial ETFs like the XLF (an ETF that tracks an index of S&P 500 financial stocks) and again it was a very rational decision. Contrary to what is being seen in other markets, even amid uncertainty, there is still a strong demand for ETFs.

Short sellers on the US stock market, that predicted overvaluation and were expecting a period of correction, got a big help from the outbreak of the virus and managed to make $105 billion in a week. This has also prompted a raise in short selling since some believe the bottom has not yet been achieved.

Moreover, some of the world’s biggest enterprises are suffering at the hands of this illness. Dow Inc., Goldman Sachs Group and Intel, alongside Apple, were the sum of main victims as “24 of its 30 components finished in the red”. For instance, Apple expressed its concerns of not being able to fulfil its second-quarter financial guidance since the outbreak has led to a cut in the production of iPhones and the firm heavily depends on factories in Shenzhen, China, and its Chinese customers. Therefore, the American multinational technology enterprise joined the number of companies that are expected to reach the bottom line caused by this pandemic.

What are the main global institutions doing to fight the coronavirus’ economic and social shock?

Governments and Central Banks have been trying to stabilize the markets and diminish the economic effects of the virus before an increase in infection cases cause tougher impacts.

Central Bankers around the world are decreasing rates or acting to ensure liquidity in the financial markets. This support has been the cause for some rallies along these weeks, keeping investors hopeful that the effect of COVID-19 in the world economy will be diminished in some part. At the start of March, the Fed moved from hinting to making an emergency interest rate cut of half a percentage point, its biggest cut in more than 10 years. As of the 3rd of March, interest rates now sit between 1% and 1.25% as Jerome Powell states that the central bank is “prepared to use our tools and act appropriately, depending on the flow of events”. Despite this action, markets reacted negatively hinting that stimulus may make borrowing cheap, but the economic menaces come from a decrease in consumption and an infected workforce. Besides the Fed, the Reserve Bank of Australia has cut interest rates to 0.5% and the Bank of England and the Bank of Japan pledged to use every mechanism in their hands to “ensure all necessary steps are taken to protect financial and monetary stability.” Even the initially sceptical ECB joined other central banks in recognizing the threat and taking arms against it.

The People’s Bank of China was the first to cut its rates and the Chinese Government is expected to increase fiscal stimulus as worries about reaching its economic targets are surging. This fiscal stimulus will probably consist in investment in infrastructure to deter the slowing in economic activity shown in recent reports.

On the other side of the Atlantic, President Trump and the government’s health-care authorities have been releasing contradictory statements in what concerns the extent of the threat this pandemic represents. While the major figure of the United States disregards the impact of the virus, stating that the risk is low and assuring Americans that they’re unlikely to die from an infection, the CDC (Centre for Disease Control and Prevention) has publicly detailed that “an American outbreak would likely cause widespread disruptions in everyday life, including closed schools and cancelled business meetings”.

On the other hand, the Chinese power aggressively acted in order to slow the spread of COVID-19, establishing a Central Leadership Group for Epidemic Response and the Joint Prevention and Control Mechanism of the State Council. Moreover, the General Secretary Xi Jinping personally directed and deployed the prevention work, making the control of the COVID-19 outbreak the top priority of the government at all levels, closing schools and other public facilities, asking overseas Chinese to reconsider travel plans and advising citizens to quarantine. Nevertheless, the attempt to silence whistle-blowers distorts the real figures of the impact the virus has had on China.

What’s next for this pandemic?

Undoubtedly, if the virus continues to spread at this pace, its impacts will reach a greater dimension. Jobs are in danger and most firms’ supply chains are jeopardized, rocking financial markets and tumbling the global economy. Some believe the worst is yet to come. It is also important to remember that the American elections are taking place in November and may have a big impact on investors sentiments. We could see trade wars between China and the US worsening if Trump gets re-elected. The world economy is in a very tight deadlock and the next months will dictate its future outcome. Is this just a glimpse of what awaits us? Either way, not much is within our reach. So, let’s just wash our hands and wait as we watch 2020’s soap opera unfold.

Sources: Bloomberg Intelligence, Market Watch, The Washington Post, CNBC, Financial Times

The world is on red alert and has “Coronavirus” as its watchword. But what is exactly this virus that has caught everyone’s attention in the past weeks? This so-called coronavirus disease 2019 (COVID-19) is identified as a new type of coronavirus that belongs to a family of viruses that cause illness such as common cold, severe acute respiratory syndrome (SARS) and Middle East respiratory syndrome (MERS). Despite its scientific definition, not much is known about it yet. Nevertheless, its contagiousness is undeniable and, despite having started in China, according to the World Health Organization, “the number of infections outside China has outpaced those inside the country”, raising the world’s concern about the rise of a pandemic that has made, until now, 3555 victims.  Yet, another question arises: is this mysterious virus only a well-being subject? As a matter of fact, this highly contagious virus is spreading beyond healthcare fields, shaking economies and tumbling global markets.

Hit-hard industries by COVID-19

Closed stores, travel bans, or cancelled conferences are some of the measures imposed in order to combat the spread of the virus of 2020. Plenty of businesses are struggling to get back on their feet and consumers’ worries keep rising after new cases emerge. China is one of the main concerns among industries, as the virus concentration is much greater in this country and the number of stores closing and shoppers sheltering at home are increasing. However, the initially-Wuhan epidemic has now expanded far beyond the Chinese city.

The travel industry is one of the largest industries in the world, with revenues around $5.7 trillion. But now, it’s being hit by travel restrictions and cancelled trips prompting a crisis towards this industry and dragging down the global economy. The international Air Transport Association, IATA, warned that global demand for air travel could fall in as much as $30 billion in revenues, the first time in 10 years. These would correspond to a 4.7% hit in global demand levels, corresponding to a 0.6% global contraction given the 4.1% expected growth for 2020.

Many big shows have been cancelled already, in an attempt to control the outbreak of the virus. Among them are Geneva Motor Show, Facebook’s F8 conference or ironically enough the leading trade show for the travel industry itself, ITB Berlin. Many companies’ business trips are also on hold, concerned about the employee’s exposure. British Airways, Ryanair, Lufthansa and EasyJet have already been forced to cancel hundreds of flights, as the airlines industry body has already warned of a falling number of passengers. Some of them are resorting to price cuts on short-haul flights, in order to dodge demand breaks.

In the tech industry, companies are already sensing the damages being caused by COVID-19 as well. The first ones being those with direct exposure to China, the supply chain of which is so dependent on this country, causing several companies to have issued a financial warning regarding the consequences of the pandemic.

Moreover, shortages in supply are expected in various products ranging from smartphones, headsets or even cars. The manufacturer Foxconn, known to be the main assembler of Apple, has stopped almost all of its production in China, who’s accountable for 75% of the production capacity of the firm. Foxconn’s revenues are down 10% compared to last year’s period. The disruption in the company’s operations has prompted questions regarding the dependence on this geographic location.

Why can this affect the global economy?

The reason is simple: China. Bear in mind that we are talking about the second biggest economy in the world and the world’s largest manufacturing and exporter of goods. Besides losses in China due to decreases in consumer spending and stores closing, the impact will extend beyond the Wuhan province.

Since the outbreak of the COVID-19 virus, there has been a tremendous amount of stoppages and even lockdowns in China’s factories, as only about 50% of them haven’t yet been harmed by the spread of the virus. This not only affects production, but also sales, since people are forced to stay at home, hence, not spending money on a wide variety of products. Furthermore, sales in China are not the only ones doomed to failure this first trimester, as sales in a lot of different sectors outside China are now compromised due to the disruption of supply chains created by all the lockdowns that have been occurring. So, basically, any company directly working with China, as for raw materials or any work in progress goods, is most likely being impacted since, a lot of companies in Europe and the United States are receiving their orders with weeks of delay and some of these can’t even sail through the Ocean due to requirements of a minimum amount of goods to fill the ships, which are simply not coming through.

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By looking at the Purchasing Managers’ Index (PMI), we can understand how severe the coronavirus has been to China’s economy given the fact that in 2008’s global recession this index had hit a low of a 38.8 score (to provide some insight, any score below 50 shows that there are more purchasing managers, in the manufacturing sector, indicating a contraction in this sector). Besides this concerning value, the IMF stated that the global spread of COVID-19 will damage economic growth for 2020. After the easement of the US-China trade relations, growth for this year was expected to surpass 2019 , whereas now “Global growth in 2020 will dip below last year’s levels, but how far it will fall and how long the impact will be is still difficult to predict” as the Managing Director of the IMF Kristalina Giorgieva said last week. This means a revision of 0.4% or higher compared to the values expected in January.

Although it is to be known at what extent, we can definitely agree that COVID-19 is taking a toll on the economy and may even have lasting effects in our lives. What remains to know is how Governments and Central Banks will react and how are investors limiting losses and even making gains during this period.

Sources: Bloomberg Intelligence, Market Watch, The Washington Post, CNBC, Financial Times

Facebook is set to launch a new cryptocurrency called Libra next year in early 2020. This new currency will allow its 1.7bn users to make financial transactions online from their mobile phone without a bank account, the company claims.

In early 2018, Facebook was accused of compromising over 50 million users’ data, having to pay $5bn for Cambridge Analytica privacy violations. This has been the largest levy ever imposed over a technology company by the Federal Trade Commission. Stocks plunged 20% and the company’s value dropped by $120bn.

Later on this year, Facebook announced that it is going to have a new cryptocurrency and financial infrastructure powered by blockchain technology, a series of immovable record of data that is managed by cluster of computers not owned by any single entity, which aims to provide and facilitate global transactions.  The company will have a new blockchain division ran by David Marcus, former president of PayPal and current head of the Libra project.

Zuckerberg and his team were initially able to gather 28 organizations for this new currency, such as Uber, MasterCard, Farfetch and Vodafone among many others. Thereby, they created the “Libra Association”, a non-profit organization, headquartered in Geneva, Switzerland, working to support financial inclusion worldwide. Each member funded the project with a minimum of $10bn. The association will focus on the reserve management, ensuring stability obtained by having a cluster of valuable assets composed by the dollar, the euro, the Japanese yen, the British pound and the Singapore dollar, with 50 percent, 18 percent, 14 percent, 11 percent and 7 percent, respectively.

The price stability will be the main differentiator from its cryptocurrency’s peers. It won’t have a fixed exchange rate, although it won’t be as volatile as, for example Bitcoin (another cryptocurrency run by blockchain technology). The reserve will amount around $200bn, an actual low number when looking into the financial markets.

Calibra will also complement this project, being the first product that introduces a digital wallet for the Libra, expected to launch in 2020. It will be available in apps like Messenger and WhatsApp, but it will also have its own app. It is claimed that it will have strong protection and be able to keep the user’s money information safe, although there is concern going around since the company’s history in data privacy is somewhat hazardous.  As previously mentioned, Facebook claims that the new cryptocurrency will reach the unbanked. You’ll just need to have a smartphone in order to send Libra instantly.

Problems might arise…

People who actually study the unbanked in the Federal Deposit Insurance Corporation have noticed that more than one third of the population concerned didn’t have enough money to open a bank account. This is something that is not solved by simply opening an online bank account. Almost half of the adults in the world don’t have an active bank account and these numbers worsen in developing countries and amid women, data released by the World Bank. So if this is the reality, will these people have access to a fully working smartphone? Even if they do, will they have digital means to buy Libra Coins?

Well, the certainty we have is that big companies like Apple, Google, Amazon and Microsoft have not yet signed up for the project, as well as banks. Mainly due to uncertainty going around future regulation that might be imposed by the authorities in order to secure central banks’ “monetary sovereignty”. Lawmakers and regulators in the U.S. have already raised concerns over this initiative. French Economy and Finance Minister already stood out saying France won’t allow the authorization of Libra into European soil given the issues inherent to the situation. China also considers Libra as a direct threat and is developing its own Central bank’s digital currency to meet the challenge imposed.

Facebook, however, has already stated that “people will increasingly trust decentralized forms of governance” (statement by David Marcus). The head of the Libra Association has already responded to the threats this project might have against financial institutions, playing down concerns over a potential disruption to monetary policies by the central banks. The reason of this being the fact that the Libra reserve contains multiple currencies, which makes Libra the one affected and not the other way around, he justifies, also adding that in case there is a currency crisis, they might decide whether or not to keep the certain currency in the basket.

Libra is designed to run on top of existing currencies, and claims the 1:1 backing of traditional currencies requires an equivalent value in government reserve in order for Libra to exist. “As such, there’s no new money creation,” Marcus tweets. He has also completed the statement saying that regulation should be created. Nevertheless, Facebook is maintaining the release date unchanged setting the launch for 2020.

Wait… Zuckerberg’s company knows the barriers they have to face to get the project launched. Most attacks to the Libra have to do with the technology and trust issues. The CEO himself has had a meeting with Donald Trump in order to discuss regulations, and how it will protect users’ data. The G7 nations have already formed a task force to look into concerns about cryptocurrencies, mainly the Libra. The firm’s own problems don’t lay solely on the decision of lawmakers, as this project has no “significant prior experience with digital currency or blockchain technology”. If problems are not settled, the digital currency might never launch.

One thing is certain, if Facebook is able to further develop and launch these cryptocurrency, they will centralize their platform users into their brand and profit from it. They may be able to use private information to personalize advertisements, their main source of income ($16.6bn at the end of last year), and eventually build a huge network of people around Zuckerberg’s empire. But first, they will have to overcome regulation and privacy hurdles. For now, because of the big controversy, some of the main companies involved the project have recently announced their withdrawing from supporting Libra, as it is the case of PayPal, eBay, MasterCard and many others.

Some of us may have been aware of the big fuss that started a few weeks ago in the “repo market” and that required the intervention of the Federal Reserve through the injection of money. But how many understand what is traded in this market and why is it important for the US economy?

What is a repo?

First, we must grasp this concept of Repurchase Agreements. A repo operation occurs when one party lends money to another using US Treasury notes (or other types of securities, although less usual) as collateral. The party that exchanges the securities for cash agrees to buy them back for a higher price at a later date, usually the following day. The difference between these prices is the repo rate

Repurchase agreements allow lenders to earn a low but secure return while holding safe securities as collateral and borrowers without liquid assets to meet their short-term obligations. Borrowers regularly consist of Wall Street brokers or hedge funds that must manage large portfolios through day operations. Lenders can be anyone with a money-market savings account looking for a short-term risk-free investment.

 

 

Federal Funds Market

Besides covering short-term needs in terms of liquidity and providing a safe investment for the agents previously mentioned, repurchase agreements are also an important money-market tool in the federal funds market. As we are aware, banks work with financial assets, loans and deposits but they require cash to manage their day-to-day operations and short-term obligations (mostly payments and other transactions). Therefore, banks (and some other parties) trade their reserves at the Federal Reserve with one another overnight through repurchase agreements. The banks with excess reserves lend them to less liquid banks in exchange for US Treasury notes that will be returned next morning for a higher price. The repo rate in this market has the name federal funds rate and is the Fed’s goal to keep it between defined lower and upper bounds.

The importance of repurchase agreements

The repo market is a vital cog in the US economy by accomplishing different functions:

• Arrange efficient short-term funding: by offering short-term deposits supported by safe securities and enabling lenders other than commercial banks, it makes funding easier, cheaper and more efficient;

• Allow the management of day-to-day operations of low-cash portfolios: investors and especially large funds don’t keep many cash assets since they are considered unproductive, so repos allow for short-term payments without the sale of long-term positions;

• Provide an accessible risk-free short-term investment: the fact that repos are collateralized by US Treasury notes makes them the perfect short-term choice for riskaverse investors such as money market funds or non-financial corporations; repos are also more available than other short-term options such as risk-free deposits at the Central Bank (only available to institutional agents) or Treasury bills (crowded primary market and tight secondary market);

• Facilitate Fed operations: due to their low-risk, collateralized nature, and efficiency repurchase agreements are a widely used instrument by open market operations to increase or decrease money supply;

• Foster price discovery: repos ease the primary market and most importantly inject liquidity in the secondary market, therefore fostering trade and arbitrage and aiding in discovering the relative prices of the securities used as collateral.

What is happening in the repo market?

Middle of September, interest rates on the obscure part of U.S lending spiked, prompting fears on broader problems. A few weeks ago, there was a big cash shortage where banks and hedge funds excessively demanded more funding that the market couldn’t supply. Monday 16th was a tax payment deadline for big companies and a holiday in Japan – which meant a large portion of funds’ sources were shut off – and after a recent Treasury auction for government bonds, there was a liquidity crunch.

These series of events shot interest rates up to 10 percent on overnight lending, more than four times the Fed’s target rate, as commercial banks saw their reserves shrinking unexpectedly. The federal funds rate hit 2.3 percent a day after, which is above the central’s bank target. This reflected in unexpected strains. (image 2.)

 

 

These increases in the interest rates of repurchase agreements were also influenced by the fact that there is less cash in the system compared to previous periods. Over the past years, the excess reserves have been declining since the Federal Reserve started shrinking its balance sheet, limiting the amount of money available in the markets. Since 2017, the Fed has been shortening their treasury and mortgage-backed securities (MBS) portfolio, now being at $3.9 trillion of assets, a significant reduction when compared to the $4.25 trillion worth of securities back in the period of 2008-2014 when there was a quantitative easing programme.

The Federal Reserve had to immediately intervene with a temporary injection of $75billion, open market operations to prevent borrowing costs from spiralling even higher. By fuelling the money market, the Fed was able to stabilize interest rates and slowly bring them to a suitable window within their parameters. It also announced the lowering of interest rates by a quarter percentage points as part of its effort to encourage economic growth, leaving interest rates between 1.75% and 2%.

The Fed chairman Jerome Powell said they had been expecting an extra demand because of Treasury settlements and the need for cash by tax-paying corporations. However, they were not expecting this amount of volatility in the market.

 

 

“The effective federal funds rate is the interest rate banks charge each other for overnight loans to meet their reserve requirements. Also known as the federal funds rate, the effective federal funds rate is set by the Federal Open Market Committee, or FOMC. The effective federal funds rate is the most influential interest rate in the nation’s economy. It affects employment, growth and inflation.”

— Bankrate Sourced

Why is or should Wall Street be concerned?

Well, any unwanted and unexpected volatility in the financial market tends to distress investors, especially in what some people think is a pre-recession phase of the US economy. However, the Fed came out to say that as they were shortening their balance sheet and reducing the excess reserves in the system it was inevitable for a moment like this to happen. This could have been seen by investors as a distraction by the Central Bank or as foreseen and expected event. Unfortunately, as in the 2008 recession, people are starting to feel like someone’s not telling them something, and adding this unanticipated rise of the overnight lending rates to the $17 trillion dollars’ worth of bonds with negative interest rates and to the inverted yield curve, they feel like something’s missing them. Maybe the real problem is not only on the shortage of reserve but on the essence of the transaction: the collateral

US Treasury bonds have been perceived for a long-time now, as risk-free securities, while still giving an average annual return of 2%. However, is it that unlikely that the US defaults on its debt obligations? If so, how can some financial institution let these considered risk-free bonds be a collateral in a repurchasing agreement that goes up to 10% in interest rates and how can the Fed lose such control over these interest rates? It may only be a normal Supply-Demand situation where lenders have that power to determine the interest rates due to the borrower’s despair, but questions about its intrinsic value are starting to appear raising concerns across the markets

As mentioned previously, the repo market, though rather unknown, played an important role in the crashing of the economy in 2008, where both the lenders and borrowers were destined to lose and lost money, since mortgages bonds were being used as collaterals with triple A ratings. When the economy suffered its great contraction and some big corporations and banks that made repos went bankrupt, the other parties were then trapped with securities that were in fact worthless. On the other side, some companies tried to save themselves in the short-term by making repurchasing agreements with the same collaterals that were now considered risky, even when lenders lost faith in these securities and withdrew their funding, leaving them with no chance of negotiating and trapped as well with them.

So, what if the US economy is heading in the same direction as a decade ago and no one is noticing it like they did then? Economists are still arguing, but still, the 16th September event may have been a sign of the times to come.

João Ribeiro Martim Leong Francisco Nunes

Do Revolut or N26 sound familiar? They are some of the most known fintechs in Europe. Both present themselves as alternatives to the traditional banking sector. The first is from the United Kingdom and the latter is based in Germany.

If you’re Portuguese, you are probably familiarized to MB Way and have heard about PPL Crowdfunding, a crowdfunding platform as its name suggests.

Fintech’s are revolutionizing modern banking, among other financial services.

Briefly, “fintech” stands for financial technology and represents the term used to name companies that exploit technological advantages to provide more efficient, lower cost and more user-friendly financial services.

Revolut is maybe the most known example of a fintech unicorn [term used to name tech companies valued above $1 billion].

Without a physical presence (it doesn’t have any bank infrastructure like Barclays or BBVA), this fintech is able to provide most of the financial services offered by the big banks at a lower cost and with a more user-friendly interface. You may transfer money between two different country-based banks without any intermediation fees for example. In this case, the United Kingdom’s based unicorn is clearly a Competitive Fintech Venture as it competes with the traditional banking sector.

Another type of fintech is what may be called a Collaborative Fintech Venture: this kind of company aims instead at complementing the traditional financial services. An example of these ventures is the MB Way service, provided in Portugal by SIBS, a company mainly held by the national big banks. It initially enabled consumers to easily transfer money between different bank accounts, using only the client’s phone number. This way, consumers have an additional feature linked to their bank account and are therefore more pleased with their banking services.

So, should the big banks feel threatened by fintechs?

Fintech is creating opportunities for customers and businesses alike, Bank of England Governor Mark Carney said.

“In the process, however, it could also have profound consequences for the business models of incumbent banks,” said Carney. So, should the big banks feel threatened by fintechs?

The BoE, in its 2017 stress test, said the tested major banks (HSBC, Barclays, Lloyds, RBS, Santander UK, Standard Chartered and Nationwide) concluded that they could withstand continued low growth and fintech competition without making big changes to their business models or taking on more risk.

[Reuters] However, the BoE stated that the fintechs’ competition could cause “greater and faster disruption” to these banks’ business models than even these institutions project.

Number of commercial bank branches in Europe (per 100,000 people)

Also, as digital payments gain terrain over the use of bank notes and coins, the ATM network in these same countries has dropped on average 2.5% since 2015, which leaves room for fintechs in the payments’ sector, like Stripe, based in San Francisco. Stripe started as a service to help small online sellers process payments and now serves tech giants like Amazon and Microsoft. It now presents other products, like a credit card issuing technology and its latest valuation, dated from Jan. 2019 was $22.5 billion.

As shown by Revolut, fintechs may weaken the relationship between customers and the banks. “For instance, in the future, it may be possible for a customer to manage their finances with only minimal direct engagement with their banks.” This will certainly make it harder for banks to maintain their high margins and profits.

Moreover, as digital banking wins over the traditional one, bankers as we know them are also at risk. According to the World Bank, the number of commercial bank’s branches per 100,000 people in developed countries like Belgium, France, Denmark, Germany, Italy or Spain have dropped an astonishing average of 5.9% since 2015 (to the last recorded year-worthy of data), which coincides with the foundation year of Revolut.

To cope with this already existing and growing competition, the big banks have to take one of two alternatives: to design on their own innovative alternatives and technologies that bring more value to customers as fintechs do; or to integrate these upcoming firms in their ecosystem, as it may be easier for these start-ups to be more agile and disruptive than for the “too big to fail” banking institutions. Otherwise, if these financial organizations also show themselves as “too big to innovate”, they are condemned to fail, to be replaced and outperformed by the upcoming fintech companies or even by big technological conglomerates like Apple, who are rapidly taking over some financial services (e.g. Apple Pay).

One thing is for sure: this competition will certainly benefit consumers and possibly even the whole economy, in which the new blockchain technology may have a relevant role to play.