Thematic Investing Is A Priority for Investors

Economic

Summary:

Insights from the latest Thematics Barometer with BNP Paribas & Coalition Greenwich.

Investors are seeking innovative strategies to drive growth and make a positive impact, according to the latest research released from BNP Paribas and Coalition Greenwich.

The latest Thematics Barometer by BNP Paribas Asset Management (BNPP AM) and BNP Paribas CIB, in partnership with Coalition Greenwich, provides valuable insights into the trends shaping the landscape.

Thematic strategies focus on identifying long-term structural themes and providing solutions driven by the overarching megatrends of technology, socio-demographics, and sustainable developments.

The benefits of such strategies are clear in this year’s survey: 63% of investors in this year’s survey cite achieving positive impact and contributing to sustainable outcomes as their leading objective, followed by improved investment returns. Innovative and disruptive nature of thematic investing, driven by interest in artificial intelligence, is also a growing trend according to the results.

The latest survey also reveals that investors are increasingly committed to thematic investing, with 89% of respondents familiar with the concept. European investors continue to lead the way, with an increase in adoption from 46% to 61% since 2020.

Beyond the net zero transition, this year’s survey results found that investors are also increasingly interested in thematics such as gender diversity, demographic inequalities and addressing water resource management.

According to Constance Chalchat, Chief Sustainability Officer, BNP Paribas CIB and Global Markets, “The results demonstrate how investors continue to be increasingly interested in sustainability thematics. The ongoing thematic focus of investors on renewables and clean energy, alongside an evolving interest in resilience, water, adaptation, AI and demographics in this years’ survey, highlights the importance investors place on these issues. The opportunities these themes present as a performance driver also provide important insights on the investment horizon ahead.”

Further findings highlight several important themes that are driving interest in thematic investing. Renewable & Clean Energy continues to be the leading sustainability theme from the surveyed respondents, with 56% to 60% of investors interested in these thematics. Artificial Intelligence is the favourite innovation and disruption theme, with 74% of investors interested in these themes. Mobility is another growing theme, with interest almost doubling from 6% in 2023 to 11% in 2024.

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Risk Warnings and Disclaimers

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Owen Li

Economic

In Keynesian prophecy, artificial intelligence (AI) productivity can be projected based on McKinsey’s guesstimate that generative AI would add 2% to 5% to the current gross domestic product (GDP). This figure is optimistic, if compared to a mere 0.66% productivity growth highlighted in a Massachusetts Institute of Technology study, whose projections calculated that not all jobs could unlock greater productivity with AI. Productivity gains could also reset as newer job roles require their own investments to cultivate, thereby diluting economist John Maynard Keynes’ possible future and sharpening the tension between AI’s uncertain gains and unpredictable impact.

Furthermore, as AI is computed in data centres, which are infamous as high energy and water guzzlers, the development and deployment of this contentious technology could be a double-edged sword.

Yet, amid these are the possibilities AI could hold for Malaysia.

AI could impact many aspects of Malaysia’s future. For example, ChatGPT could be seen as groundbreaking and hold immense potential across multiple fields. In learning, it could unlock new dimensions of human intelligence and potential. Conversely, it could be regarded as the mother lode of disruptors, bearing security risks and ethical issues where the cumulative advances in ChatGPT are said to have the potential of rendering many educators irrelevant.

The future of the Malaysian cadre could be shaped by the technology whose impact ranges from unexplainable to well-nigh dangerous. Yet, to restrain development and the economy from AI deployment could risk impacting the nation’s competitive future. After all, management consulting firm Kearney’s projected addition of US$1 trillion (RM4.2 trillion) to Southeast Asia’s GDP is a tantalising goal.

Rethinking AI policy

To achieve the good while mitigating the bad, Malaysia would have to reflect on domestic AI policies, not only on the means and ways the technology might impact society or the economy, but also to direct AI’s development as an industry to advance its goal of becoming a developed nation.

Malaysia is not short of plans to deploy or develop AI. The AI Roadmap 2021-2025 and 10-10 Malaysian Science, Technology, Innovation and Economy (MySTIE) Framework sought to strengthen the AI ecosystem for developers and R&D. Meanwhile, the New Industrial Master Plan 2030 (NIMP) cites AI as a possible sector to boost the country’s semiconductor design ambitions. NIMP hinges on economic complexity as Malaysia’s vision of becoming a high-income nation, whereby complexity is gauged by the nation’s productive capabilities to produce diverse and complex goods. However, the plans are not interlinked in an ecosystem which could kick-start an AI industry. This could take a page out of early AI policies in Japan and China that sought to invigorate the market by encouraging AI production in smart cities or smart-home appliances.

Malaysia should take advantage of the semiconductor industry and cultivate a value chain that has both software and hardware components, thus starting in code and possibly finishing in chips powering computers. This would not be impossible as the country has already displayed ambitions to move to the front end and enhance capacity in the back end of chips. Efforts for an integrated design park, such as the semiconductor accelerator and integrated circuit (IC) design park, are aimed at gathering local and global IC design houses to synergise collaboration. While this is indeed a laudable move to add value along the semiconductor supply chain, it is still too early to tell whether it could reap the low hanging fruit, especially if the complementary ecosystems are not present.

But is that enough? Certainly not, once we get down to the elephant in the data room — computing power — without which Malaysia’s AI future will remain bleak.

Environmental concerns

Calculations of computing power can vary, especially on the AI being trained. Yet, training any AI would consume energy, especially to dissipate heat. Furthermore, training AI produces more data, which means more space. Market intelligence provider TrendForce estimates that it would take 20,000 graphics processing units (GPUs) to train the generative pre-trained model underlying ChatGPT.

At commercialisation, the figure should reach above 30,000, especially because of data generation and user numbers. Chips would have to be produced with sustainability in mind, while data centres need to find ways to keep cool. In other words, the digital economy cannot be cleaved from the green economy, which explains the concerns about the flurry of data centres on Malaysian shores. Data centres account for 1% to 5% of the world’s total greenhouse gas emissions while, comparatively, emissions from the aviation industry make up 2% to 3%. It doesn’t end there, as the consumption of electricity will exceed 5,000mw by 2035 in Malaysia alone. On average, a data centre with the capacity of 100mw uses more than 4,000 cu m of water per day for cooling.

Between 2021 and 2023, Malaysia attracted RM114.7 billion in data centre investments, competing for limited resources in regions where they operate. And there’s the rub: Where do we draw the line between economic growth and environmental degradation?

The pressing question is whether these incoming companies have the necessary skills and resources to minimise their environmental impact and commit to green operations. The usual trade-off contentions apply: stringent regulations might raise concerns about slowing foreign investments. But the emphasis should lie on attracting high-calibre investments that align with the country’s long-term sustainability objectives, such as the National Energy Transition Roadmap.

Now, getting high and mighty about the imperative for going green may look good on paper but reality bites hard. In 2020, 50.9% of the peninsula’s electricity was generated from coal, which raises questions about our ability to supply sustainable energy to the expanding data centre sector. Achieving a balanced energy mix is crucial to support these dual objectives of aligning the nation’s renewable energy goals and digital ambitions. Hence, a cost-benefit analysis is needed to balance the economic gains with environmental sustainability.

Climate solutions

Malaysia could benefit from adopting a model like Singapore’s Green Data Centre Technology Roadmap by allocating capacity to data centre operators that prioritise sustainability alongside economic value. It is worth noting that the Malaysian Communications and Multimedia Commission (MCMC) introduced a technical code for green data centres in 2015. This technical code is now undergoing revision to match present technologies. Although it guides operators in enhancing energy efficiency and reducing carbon footprints, it remains non-binding and voluntary.

Meanwhile, the Ministry of Energy Transition and Water Transformation (Petra) and the Ministry of Investment, Trade and Industry (Miti) have announced that Malaysia can expect a robust framework focusing on energy and water efficiency. Undoubtedly a welcome move, this framework is set to introduce innovative solutions, moving from guidelines to enforceable standards.

Nevertheless, there needs to be active inter-ministry discussions to facilitate communication between the relevant agencies overseeing standards and compliance. For instance, the technical code serves as a baseline in developing a framework based on established principles and best practices. These need to be enhanced in areas, such as reliable and resilient water supply, water resource management and other critical public services. Siloed approaches would be counter-productive, especially in a cross-cutting sector such as information and communications technology (ICT).

Hosting more data centres, Malaysia should fully harness AI and technological innovations to advance transformative climate solutions for mitigation and adaptation in as much as creating a thriving digital economy must stem from a multi-dimensional approach that dynamically seeks to exploit the opportunities for growth and expansion while never losing sight of our planet’s limits.

Source: The edge markets

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Central Bank

Economic

More rate cuts on the way in the fourth quarter of 2024

Another round of central banks’ meetings has been completed with the Fed stealing the show by announcing the start of its easing cycle. The ECB, the Bank of Canada and the Swiss National Bank followed suit in support of their ailing economies or to weaken their currencies. On the flip side, the remaining central banks opted to stay pat and evaluate their economies' progression.

Looking ahead to the fourth quarter, and despite the elevated core inflation rates, the expected economic slowdown will most likely allow most central banks to announce further rate cuts. However, certain events like the November 5 US presidential election, and a likely escalation in the Ukraine-Russian conflict and a war in the Middle East could derail their efforts.

Fed vs ECB: easing to continue

When examining the underlying economic strength of these two regions, one could quickly reach the conclusion that the US is still the strongest economy as it continues to grow at a respectable pace and that inflation remains somewhat high. On the flip side, the eurozone is experiencing a very soft patch with Germany being the weakest link and flirting with another yearly contraction. Additionally, euro area inflation has eased considerably, as the headline rate is currently hovering a tad above the 2% target.

However, the Fed is concerned that the expected slowdown could stop it from meeting its dual mandate of price stability and maximum employment. As such, the market is currently pricing 77bps of extra easing by year-end and a total of 178bps of rate cuts by mid-2025. Oddly, despite the bleaker economic outlook, the ECB is seen cutting by 46bps in 2024 and by 142bps by mid-2025.

Central Banks Easing: the Race to the Bottom has Officially Commenced_1

BoE and SNB to announce further cuts

Despite the Bank of England's inherit dovishness and headline inflation dropping aggressively, Governor Bailey et al have opt for a more conservative approach as the UK data remains consistent and they want more time to evaluate the expected fiscal tightening by the new government. However, the market believes that the BoE will announce 40bps further rate cut during 2024. A total of 122bps of easing is priced in by mid-2025, much less than the Fed.

Similarly, the SNB is seen maintaining its monetary policy easing strategy in order to boost its subdued inflation outlook and further weaken the Swiss franc. There is a 60% probability of another 25bps rate cut at the December meeting, with a total of 48bps of easing priced in by mid-2025, on top of the already announced 75bps reduction.

RBNZ and BoC on autopilot mode

Both the Bank of Canada and the Reserve bank of New Zealand are expected to keep their foot on the gas by announcing 68bps and 93bps of easing respectively by year-end. These levels rise to 160bps and 214bps by mid-2025 as the economic slowdown is expected to become more widespread.

In the case of the BoC, the oil price outlook and expectations for aggressive Fed easing will probably leave governor Macklem et al with little choice but to cut further and cut deeply. In the meantime, the RBNZ is already in autopilot mode, as its own mid-August projections pointed to a significant monetary policy easing over the next 12 months.

Central Banks Easing: the Race to the Bottom has Officially Commenced_2

BoJ could hike again, RBA to follow a more conservative approach

The RBA has, up to now, bucked the trend by remaining relatively hawkish as Governor Bullock et al remain dissatisfied with inflation's medium-term outlook. This situation could become more complicated if China's renewed set of stimulus measures produces fruit. A possible growth pickup in the world's second largest economy could materially impact its main trading partners.

Finally, the Bank of Japan continues its lonely road of monetary policy tightening. It has managed to hike by 35bps in 2024, but the market is less confident about its ability to announce another rate hike by year-end, especially as the Fed commenced its rates cutting cycle. The market is pricing in only 4bps of tightening in 2024, which means there is room for a surprise if the data allows it, with a total of 15bps of rate hikes expected by mid-2025.

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Alex

Economic

Saudi Arabia is ramping up its adoption of advanced mining technologies as top minister met with senior executives from the US firms at MINExpo International 2024.

During his visit to Las Vegas, Minister of Industry and Mineral Resources Bandar bin Ibrahim Alkhorayef held bilateral meetings with these firms to discuss localizing innovative solutions for mining operations and exploring promising investment opportunities in the sector.

The discussions aimed to bolster the Kingdom’s mining industry and enhance its global competitiveness, the Saudi Press Agency reported.

The Kingdom aims to establish mining as a foundational industrial pillar, with its mineral wealth estimated at SR9.4 trillion ($2.4 trillion), according to a recent release from the Ministry of Industry and Mineral Resources.

In addition to mining discussions, the minister explored collaboration with advanced industries, including a visit to JetZero, a California-based aviation company, and a tour of SpaceX, a leader in space exploration technologies.

In a post on his X account, Alkhorayef said: “During my visit to the US state of California, I was briefed on the advanced technologies possessed by JetZero and SpaceX, the two leading companies in their field, and discussed with them enhancing cooperation in the aviation and space industry sector; in line with the Kingdom’s goals and targets in the National Industrial Strategy.”

In the mining sector, Alkhorayef, along with his deputy for mining affairs, Khalid bin Saleh Al-Mudaifer, engaged in discussions about potential investments with Michael Wright, CEO of Thiess, a prominent mining services provider with operations across Australia, Asia, and the Americas.

They evaluated strategic targets outlined in the Kingdom's comprehensive mining strategy and extended an invitation to Thiess to expand its regional footprint in Saudi Arabia.

Alkhorayef also met Jon Stanton, CEO of Weir Group, to explore opportunities in the valves and pumps sectors, which are experiencing rising demand due to major oil and gas projects.

The valves sector was valued at $9.8 billion in Saudi Arabia by the end of 2022. The minister emphasized the potential for establishing a local manufacturing facility for pumps and valves to enhance the sector’s capabilities.

Furthermore, Alkhorayef engaged with Richard Harris and Petri Virrankoski from Sandvik to discuss investments in mining machinery and surface drilling solutions, highlighting Sandvik’s role in advancing operational efficiency through innovative equipment and digital solutions.

The minister also met with Dave Goddard, head of mining at Hexagon, who outlined Saudi Arabia’s digital transformation across various sectors, including mining.

Alkhorayef presented initiatives like the Future Factories program, aiming to automate 4,000 facilities, which could facilitate Hexagon’s expansion and address the growing demand for software solutions, including AI applications.

In discussions with Otto Breitschwerdt, chief technology officer at Caterpillar, Alkhorayef highlighted promising opportunities in heavy equipment and diesel generators amid the Kingdom’s ambitious development plans.

He noted that the heavy equipment market is projected to exceed $4 billion, while the diesel generator market is expected to reach $550 million by 2030.

Alkhorayef also met Dan Lankford, chairman of Impossible Metals, to explore the latest solutions in offshore mineral exploration. Impossible Metals is developing underwater robotic vehicles for critical mineral extraction and has successfully tested its autonomous underwater vehicle, Eureka II, in deep waters.

Source: ARAB

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Justin

Economic

The world is on a speed highway for new technologies. The design, creation, testing and adoption of new technologies has accelerated exponentially since the Industrial Revolution. It no longer takes decades, but days, for the masses to adopt new technologies. The Generative Artificial Intelligence (GenAI) and Large Language Model (LLM) revolution is further propelling the world to yet another brand new reality.

What are the implications of this powerful new technology? How is it reimagining the future of financial services? And how can we balance innovation with human responsibility for an ethical usage of AI? Speakers on a recent panel discussion at the BNP Paribas Global Official Institutions Conference (GOIC) shared their insights.

The Transformative Impact of GenAI on Financial Services_1

What are the implications of GenAI on financial services? Speakers on a recent panel discussion at the BNP Paribas Global Official Institutions Conference (GOIC) shared their insights.

Generating content with AI

Opening the discussion, Alexei Grinbaum, Senior Research Scientist at CEA-Saclay, explained: “The way AI systems generate content is asemantic. Generative AI systems don’t understand anything as human do and do not work with the dimension of human meaning. Computation just serves to select the next token in a sequence. Token selection is the result of probabilistic computation, and that’s all GenAI does. What is interesting is that, although GenAI only computes missing tokens, it actually produces content that makes sense to us and appears to be full of meaning to the user.”

He added: “AI generation doesn’t evaluate whether some content is true or false, because human meaning is not part of the computation process. We need to add a system of filters, called alignment, to filter out what is wrong, discriminatory, or toxic.”

GenAI remains a machine. The quality of what it delivers depends on the prompts we give it: “In order to speak to this non-human agent, you need to learn specific ways of speaking.” We cannot just use human ways of using language and assume that this would give the best result with the AI systems.

The adoption of GenAI

After Carl Benz created the very first gas powered vehicle in 1886 during the Industrial Revolution, it took 27 years before its adoption became more widespread when Henry Ford brought it to the masses in 1913.

In comparison, when ChatGPT was launched in November 2022, it took five days to get 1 million users. The previous record was held by Instagram for which it took two months to reach that number of users, said Guillaume Bour, Head of Enterprise at Mistral AI, speaking at GOIC.

Adoption of GenAI has been lightspeed, applications seem endless and the race to the next frontier has started. Making the technology free for use on open source will further accelerate the transformational nature of GenAI.

Among sectors, financial services are one of the industries at the forefront of AI adoption, with a growing number of explorations in the past 18 months as well as a shift from employee centric and on non-core business applications which were mostly off-the-shelf solutions to business use cases with much more significant gains in competitive edge, Bour noted. A majority of use cases he has seen have been tools that improve more administrative, behind-the-scenes, tasks, such as credit decisioning, know-your-customer (KYC), ESG and risk management improvements.

Client-facing applications are the next level competition as companies increase the AI capabilities of their client-facing contact centre chatbots. Swedish e-commerce startup Klarna, for example,claims to havea chatbot that can manage over 2 million customer conversations in a month without negatively impacting its Net Promoter Score (NPS) which measures customer satisfaction.

The provider’s view

Being a good provider requires two key ingredients: expertise and capital. Bour estimates that there are currently a few thousand people in the world who master this technology. On the capital side, developing GenAI models is very capital intensive because it needs to run a lot of GPUs non-stop for days or even weeks.

Big, powerful models are important for research, but not always financially viable when going into production and scaling. “Return on investment is not obvious for many use cases,” Bour noted. “In order to support the scale of large enterprises and institutions around the world with the most efficient cost-to-performance ratio, you will need big, very powerful models, which are more expensive, but also mid-sized models that you will be able to fine tune and specialise to specific tasks.”

Bigger models have more reasoning capacity and ability to perform more advanced tasks, and are also slower. The industry needs to find a balance in the trade-off between speed and reasoning capacity.

Taking the example of legacy code refactoring, Bour explained: “If you want to translate millions of lines of COBOL to Java, which is a challenge that many financial institutions face, it needs a lot of accuracy and performance for a model. This can take days or even weeks, which doesn’t really matter. On the other hand, if you are building a chatbot for your customers, then latency is extremely important. So you would rather choose smaller models that do have a very good level of performance as well.”

Another differentiating factor for Mistral is the company’s flexibility to deploy its models within their clients’ data centres instead of putting the data in the cloud, which is definitely a selling point for financial institutions. “We believe that our customers should have the choice of bringing the model to the data and not the other way around,” Bour noted.

Multilinguality is another key feature: It is the ability for a model to understand and to communicate natively in a specific language instead of using translation. This ensures the model understands cultural sensitivities and nuances. “It’s not only about vocabulary or grammar, but also about the cultural aspects, and distilling the specificities of a language and a culture,” said Bour.

The users' view

French financial markets regulator, Autorité des Marchés Financiers (AMF), considers itself as “AI consumers,” said Iris Lucas, AMF Head of Data Intelligence. “Indeed, at the AMF we are asking ourselves the question of use for our own purposes and several projects are underway, for example investors’ protection, promotion of sustainable finance, market abuse detection, and operational efficiency.”

AMF deployed its first AI tools in 2019, with a scam detection called FISH, Financial Investment Scam Hunter. In 2021, AMF launched of a big transversal data programme called ICData, with the ambition to extend the use of data in order to make the AMF more data driven.

On sustainable finance, AMF is using AI to extract the sustainability objectives in fund management policies. AI is also a valuable tool AMF is using for clustering in market abuse detection while supervised learning techniques are being explored to identify specific types of market manipulation. In operational efficiency, AMF is exploring the use of AI for automatic generation of meeting Minutes, support for experts, and increased supervision assistance, to reduce manual tasks without added value. “Our point of view is that LLM will not replace our coworkers or experts, but it can extend their capabilities,” Lucas noted.

Looking at the use of AI at financial institutions, Léa Deleris, Head of Risk Artificial Intelligence Research at BNP Paribas, explained: “My team develops AI use cases to help the efficiency and efficacy of risk management. We also work on the strategy of the function and contribute at the Group level to all the community around AI, especially around responsible AI, that is ethical, secure, robust, bias free, mindful of the carbon footprint, and explainable.”

She added: “We have over 50 use cases in production that address risk and compliance use cases, mainly in identification and detection.”

Deleris sees most of the impact of GenAI on documentation and controls. Large global institutions like BNP Paribas have controls in very diverse geographies and jurisdictions. “At the level of BNP Paribas Group, we want to make sure that we cater to the local specificities while ensuring we keep a global coherence. Having a tool that can read, summarise and find challenges will help us be even more efficient,” she noted.

Head of Risk Artificial Intelligence Research, BNP Paribas

Other areas where AI can provide significant efficiency is in modelling, stress testing, speed up documentation and alignment to procedures and regulations.

Responsible AI

“Beyond the benefits and challenges in implementing AI, an essential topic for all of us is how to do it in a responsible way,” said Hugues Even, BNP Paribas Chief Data Officer, who moderated the discussion.

This is the purpose of the EU AI Act which is “aimed at creating a unified legal framework for AI systems and applications across the European Union (EU),” explained Deleris, adding: “The intent of the AI Act is to ensure that AI systems are developed and deployed in a safe, ethical, and trustworthy manner.”

The AI Act categorizes AI systems based on their level of risk and introduces specific obligations and requirements for each category. High-risk AI systems will be subject to strict compliance obligations, including conformity assessments, data governance, and transparency requirements.

Deleris cautioned that the AI Act only focused on protecting a category of risks affecting the fundamental rights of citizens. Institutions face additional risks such as cyber but also operational or reputational loss from improper use of AI. “Model risk management is not new in financial institutions and is exactly about ensuring that a model (AI or not) is fit for purpose and used in the correct purpose. So we already have frameworks and mostly need to nurture a culture of managing those risks,” she added.

“While the AMF does not currently supervise AI models developed by market participants under the AI Act, this may evolve in the future as regulations progress. In the meantime, we are actively engaging with market players to understand how AI is being used and whether it impacts their compliance processes or risk management,” noted Lucas. She added that “The key challenge remains to strike a balance between leveraging the opportunities AI offers and managing its risks. This is central to the AMF’s ambition: to support innovation while ensuring the proper functioning of the markets.”

Grinbaum at CEA-Saclay agreed: “The AI Act is not just more bureaucratic procedures and more mandatory certificates. There are also very interesting provisions – even a new ethical principle – and important calls for more research.”

“The rapidly evolving technology of Generative AI offers opportunities for early adopters in their markets, and the potential of and use cases already being implemented in areas such as modelling, detection, investigation and reporting. This also call for controls and ethics considerations, and the potential for regulation including the EU’s landmark AI Act,” concluded Even.

Source:Bank of America

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Justin

Economic

Forex

Several interesting changes have taken place in the European cross-border trade landscape in recent years. Although the majority (59.9%) of EU trade – imports and exports combined – still occurs within the single market, there has been a notable transition in the focus of bilateral trade towards emerging economies, especially China.1 Whereas trade interactions with long-standing partners have seen less fluctuation in the same period.

Trade statistics tell the story

The shift in trading partners is especially noticeable on the imports side. China was the EU’s principal partner for imported goods in 2022 with 20.9% of the total share, up from 7.8 % in 2002, according to the most recent full-year data from Eurostat.2 The US came in significantly behind China at 11.9%, followed by the UK, Russia and Norway.

Meanwhile, the main destinations for goods exported from the EU included the US, the UK, China, Switzerland and Türkiye, among others. Again, China saw a huge leap in the two decades from 2002, with the value of the country’s share of EU exports growing by a staggering 603% in that time.3 Nevertheless, the EU posted a record trade deficit with China of €390bn in 2022 pointing to a significant imbalance between imports and exports.4

Europe’s New Trading Partners: Managing FX Risks and Shifts_1

Trading places

Europe’s traditional trade relationships have experienced heavy disruption since 2020 due to Covid, the increase in geopolitical tensions, including the ongoing impact of Brexit, rising interest rates, terrorist attacks disrupting cargo routes, and international sanctions.

This uncertainty is leading to greater interest in trade solutions, with a marked uptick in the need for inventory finance, as well as ESG-compliant solutions. Corporates are looking to reinforce their supply chains against further possible disruptions, which means having sufficient raw materials on hand to produce their goods and enough inventory to fulfil demand in a timely manner. But higher inventory can weigh heavily on working capital, so inventory finance is experiencing a resurgence among European traders.

Corporates are also making their supply chains more resilient by sourcing from new or additional locations. Alongside China, raw materials from countries such as Mexico and Türkiye are increasingly common in European supply chains. As a result, the currencies in which Europe’s trade transactions are carried out are also evolving at speed.

Europe’s New Trading Partners: Managing FX Risks and Shifts_2

FX risk and hedging

As European trade with China, India, Brazil and many other smaller emerging market countries grows, treasurers are suddenly being exposed to a whole new basket of currencies, which have financial risk implications in terms of exchange rates on international payments and hedging strategies.

Most treasury teams will be managing and monitoring these additional risks with the same resources. This has led many to adopt a systematic approach to hedging secondary exposures in order to focus efforts on managing their primary exposures.

But achieving this is not always easy. Hedging emerging market currencies can be much more complex than hedging the pound sterling, for example. It often requires understanding of local regulation, the factors affecting the value of the currency and liquidity conditions. It can also come at a higher cost.

Treasury teams can adapt to different environments by thinking smart about hedging: they can optimise the maturity of their hedges to keep hedging cost to a minimum, or selectively use options.

Source:Barclays

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UBS

Central Bank

When the top policymakers in the world’s two largest economies are determined to support economic growth, it pays to listen. On September 18, the Fed kicked off its easing cycle with a 50 basis point cut, delivering a strong message that the central bank will not hesitate to act aggressively to ensure a soft landing. A week later, China’s Politburo delivered a forceful message that fiscal policy will be engaged to reduce downside risks to growth, notably by directly supporting the Chinese consumer in earnest for the first time under President Xi. While there remain lingering concerns on US labor market momentum and policy implementation in China, we would not underestimate renewed policymaker resolve to cut off the left tail on domestic and effectively global growth. We believe that there is further room for markets to price out recession risk across asset classes.

A proactive Fed

After the Fed kicked off its easing cycle with an uncharacteristically large 50 basis point cut, Fed Chair Powell said: “the labor market is actually in solid condition. And our intention with our policy move today is to keep it there.” Powell clearly wanted to signal a Fed reaction function that will be proactive, and was able to convince the rest of the FOMC to back it up with a powerful action. This suggests that the bar is low for the Fed to continue easing at an aggressive pace should the labor market disappoint even somewhat in the near term.

At the same time, we are not convinced the Fed will need to ultimately deliver on all the rate cuts that are priced into the market over the coming year. Hard economic data have been surprising to the upside for weeks, with consumption looking robust and initial jobless claims remaining low. Even though the Fed has only just cut rates, there are nascent signs that the easing of financial conditions earlier this year are having a positive effect on the housing market, with new home sales, housing starts and building permits all surprising to the upside of late. Finally, the US Bureau of Economic Analysis just meaningfully revised its measurements of Gross Domestic Income, leading to a sharp upward revision in the estimated US savings rate from 3.3% to 5.2% for Q2. This had been a key argument used by US economy bears that the US consumer was spending beyond its means and due for a sharp retrenchment. In short, the Fed does not look like it is behind the curve.

Exhibit 1: The personal Savings Rate was revised significantly upwards

Personal savings as a % of disposable personal income

Source: Source: BEA, UBS Asset Management. As of September 2024

An inflection point for China

Until last week, China’s stimulus measures have been woefully inadequate to cushion the economy against ongoing deleveraging in the property market and deflationary pressures. The underlying economy has suffered from low private sector confidence, which policymakers had been reluctant to support in full, amid a preference to direct resources at the supply side (infrastructure investment) over demand side (consumption) of the economy.

That said, the coordinated set of monetary and fiscal policy announcements last week designed to support the housing market, capital markets and the consumer do signal a shift in strategy from the government to revive sentiment and dynamism in the private sector. In the spirit of listening carefully when policymakers speak, we note that the September Politburo, which was the first unscheduled meeting of China’s top economic policymakers since the depths of COVID in March 2020, used forceful and focused language on steps to revive the economy.

Leaving out prior Politburo references to structural issues, moral hazard and national security, the readout showed determination to achieve its ‘around 5%’ real GDP target, stop the real estate market from falling, and acting with urgency to ensure necessary fiscal support for the economy. Most notably, language and news since the statement suggest the first genuine direct support for consumers themselves, something that had seemed ideologically off limits in prior communications. Also notable, was the stated need to ‘respond to the concerns of the people;’ this may suggest the Politburo’s growing concerns over social stability, which could have motivated a shift to demand-supportive policies where there was previous reluctance.

While there are many details to be ironed out, including questions on the size and scope of fiscal support, we think the shift in language signals a genuine turn in China’s policymaking reaction function. There is a clear message to address downside risks, and potential for additional stimulus measures announced in coming weeks.

Defensives at risk

Policy shifts from the Fed and Politburo come just as investors had started to send a wave of money towards more defensive assets. According to the popular Bank of America fund manager survey, investors in September reported their biggest overweight to defensives vs. cyclicals since May of 2020. Indeed, the UBS cyclicals vs. defensives equity basket had fallen sharply over recent months; we think it has further room to rebound from here. Separately, asset managers have built up a large overweight position in US government bonds, according to the CFTC and J.P. Morgan’s client survey. Regionally, we have downgraded US Treasuries from overweight to neutral as the US economy looks resilient. The more proactive the Fed is today, the less they will need to ultimately deliver further out in time.

Exhibit 2: Still room for cyclicals to outperform defensives

Source: Bloomberg, UBS Asset Management. As of September 2024

In equities, we have upgraded China and emerging markets, which remain attractively valued even after China’s stimulus announcements. According to fund flows specialists EPFR, China allocations in active equity funds were close to 10-year lows at the end of August. While European equities should also receive some boost from China’s stimulus, particularly exporters of luxury goods, Germany’s economic weakening and ongoing manufacturing headwinds keep us underweight. US equities remain overvalued, but as mentioned above, we see further upside for more cyclical sectors versus defensives.

More broadly, we favor overweights to Asia and European credit, where there is more attractive carry than in US credit. We also are long the Brazilian Real and South African Rand, which offer carry and further potential upside as China reduces global growth risks. Our overall position in duration is neutral, but we remain short JGBs as the market continues to underprice the further tightening we expect from the Bank of Japan.

We acknowledge that after the recent surge, there is risk of disappointment with policy delivery in China, not to mention geopolitical risks including the potential for a US election victory for President Trump who has threatened a surge in tariffs on China. The MSCI China Index is much more heavily weighted towards the domestic services economy and therefore would be less directly impacted by tariffs on Chinese exports. Still, there are risks that a shock to confidence could be a headwind for the current global reallocation back into China. As always we will be monitoring the risks to our position into upcoming risk events.