Friday, April 26, 2022

The Current Macroeconomic Outlook and Our Product

A group of changing macroeconomic conditions have been a centerpiece for the first quarter of
2022. These include rising global commodity prices, supply chain disruptions, Federal Reserve
Interest rate hikes and the return of War to Europe. All of these have brought new levels of
uncertainty into the marketplace and sentiment for investors. Understandably, these changing
conditions have raised concerns and questions amongst our client base. This presents us with a
great opportunity to share a few points and observations with you concerning these
macroeconomic conditions and their relation to your portfolios with us.

In this write up we would like to briefly analyze major points of observation for six conditions or
flash events that we identify as being significant towards the addition of uncertainty into the
marketplace. These observations would include global supply chain disruptions, commodity
price inflation, liquidity risks, trading risks (counterparty and margin), bond market defaults, and
currency devaluations. Secondly, we’d like to explore the relation that these macroeconomic
factors bear on our business model and trading product.

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Major Macroeconomic Observations

1. Global supply chain disruptions spread at the onset of the Covid-19 pandemic. These
disruptions continue to linger and are a source of a major challenge to the world economy. The
US Bureau of Labor Statistics maintains the Global Supply Chain Pressure Index (GSPCI), which
we have identified as a great measure to quantify and capture the disruptions that supply chains
have experienced worldwide.

This chart shows how the GSCPI has increased to record high levels since 2019 when the Covid
19 disease began to spread triggering the lockdowns, travel restrictions, and the changes in
production and consumption behavior we are all familiar with (and likely increasingly tired of!
lol).

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The data used to comprise this chart is dated up to the end of February 2022. Therefore, any
additional supply chain disruptions that might be a result of the War in Ukraine, sanctions on
Russia, or any other economic fallout in response to that conflict, has yet to be incorporated into
this index (The Ukraine war is recognized to have started on Feb 24th 2022). Therefore, it is highly
likely that what economists had lauded as being indicators to a reduction in global disruptions at
from the decreasing trend at the end of 2021 and Jan/Feb in 2022 may be short lived.

Furthermore, the challenges to global supply chains can be challenged in different ways than
were created out of the Covid-19 pandemic. For example, before the war, Russia and Ukraine
account for approximately 25% of the global wheat export market and Ukraine accounts for 80%
of global sunflower seed exports. This production will most certainly be disrupted by this conflict
and/or resulting sanctions creating shockwaves in global food security and supply chains yet to
be determined.

2. Commodity Inflation has been a direct result of the global supply chain disruptions coupled
with the impact of war in Europe. Before the outbreak of this conflict, in most of 2020 and 2021
the Federal Reserve economists forecasted the commodity inflation phenomenon to be
“transitory” (resolved naturally in the near-term) due to its short-term origin of pandemic related
economic shut-downs. The general belief was that as production and consumption levels
returned to a level of normalcy, the supply and demand equilibrium would be restored alleviating
any momentary price hikes

The Federal Reserve has since appeared to have dropped their “transitory” analysis in 2022. The
Federal Reserve moving forward are seemingly sharing (or at least acknowledging) the sentiment
that the conflict in Ukraine and the subsequent economic sanctions on Russia are expected to
both exacerbate and prolong rising global prices. It must be pointed out that commodity price
jumps we are experiencing now are akin to levels not since experienced since the 2008 global
financial crisis.

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3. Liquidity Risks also have begun to permeate into financial markets as sentiments change
among investors and uncertainty increases. Wild swings in asset prices (such as aforementioned
wheat) due to inflation has triggered many investors to reduce exposure in their portfolios to
commodities. Investors change their allocation strategies out of fear that price volatility in
commodities could create contagion in other markets. This could manifest in equity market sell
offs, or bond defaults as companies and countries’ solvency are challenged.

These concerns center around the main issue of liquidity – briefly defined as the ease that an
investor is able to buy or sell an asset without affecting its price. When a market is highly liquid
that means an investor is able to quickly sell an asset when they need to without facing any
restrictions, disruptions, or hemorrhaging of cash. If a marketplace is not liquid or shows any
signs of lower liquidity levels, then assets may be subject to violent price swings or the inability
to exit a failing trade which can wreak havoc on an investment portfolio (let alone an entire
country’s economic and/or political stability!)

Two brief developments we witnessed in financial markets related to liquidity risks were:

1. Trade limits being increased over consecutive days in the wheat futures market after a
surge in wheat prices
2. Large financial institutions like Barclays suspending sales of products linked to crude oil
and market volatility at various points in March

AS mentioned earlier, liquidity risk can wreak havoc on a portfolio and it is unclear what other
sources of liquidity risk will be experienced moving forward.

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4. Trading Risks: Counterparty and Margin Risk are also of great concern to investors in
conjunction with the issues already laid out. Counterparty Risk has to do with the probability of
someone defaulting on a contractual obligation linked to a commodity (or any other underlying
asset) transaction. While Margin Risk has to do with the inability of an investor to pay back on a
loan taken from a brokerage firm to purchase securities.

We saw both risk events send shockwaves in the global Nickel market after one of the world’s
top nickel tycoons, Xiang Guangda of Tsingshan Group Holding Co, bought immensely large
amounts of nickel. Xiang made this enormous purchase of Nickel in order to cover his incorrect
bets on falling prices in the Nickel market and the subsequent debts he owed on making this bet.
The nickel market saw prices spike as much as 250% in two days and was brought to a complete
standstill at points in March until a resolution was able to be negotiated in order to allow trading
to resume.

This Nickel issue and the debts accumulated by Xiang have yet to be fully resolved and it also
unclear as to what other defaults or trading problems similar to this one will evolve in other
markets.

5. The Global Bond Market has seen higher levels of uncertainty in response to recent events as
well. At multiple points Russia was facing potential default on its bonds since it was unable to
process payments of dollar-denominated (Please take note that Russia’s debt was dollar
denominated. We will explore that importance later.) through foreign banks due to newly
minted economic sanctions. In March, bond defaults were able to be avoided through a series
of negotiations with financial institutions in spite of the sanctions not necessarily because
sanction restrictions were lifted. Hence, in April when Russia once again needed to make its
monthly series of payments on bond obligations, they were once again stymied. This time
however, no negotiated agreement was found on how to process payment and as of this writing
Russia is in default. It is unknown for how long this defaulted status will continue in the near
future.

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This bond default event and the increasing economic insecurity expected across the developing
world has resulted in a loss of confidence in emerging market bonds overall. Bank of America’s
(BofA) Global Research pointed out in March they saw highest net outflows from emerging
market bonds since April 2020 (3.54Billion). BofA inversely reports an increase in Treasuries
investments during the same period hinting at capital leaving emerging economies and settling
for the US economy.

6. The Russian Ruble experienced a massive currency devaluation through the first days of the
conflict in Ukraine. The Ruble lost roughly half of its value going from 84 rubles per dollar prior
to the war to as high as 154 rubles per dollar by March 7th. The Ruble has since regained its value
after its precipitous drop where it is currently trading at 82.75 per dollar. However, this massive
swing in pricing has created volatility in the foreign exchange markets and, rightfully so, raised
concerns amongst our client base of how a violent swing of this nature affects our trading
program and whether a sustained value of the United States Dollar can be expected moving
forward.

Taking into consideration all of the macroeconomic changes outlined above that have hit
financial markets, it presents a perfect opportunity for us to re-introduce our client base to the
nature of our product and the risks associated with our investment and trading model.

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Our Product in Relation to The Above-Mentioned Macroeconomic

Observations

QYU prides itself on being a group of professional traders focused primarily on the foreign
exchange market. Therefore, we mostly operate in a marketplace that operates and functions
vastly different than that of the commodities, equities, or bond markets mostly mentioned above.

Furthermore, the trading approach we take follows an intra-day strategy. With this short term
strategy we take advantage of price fluctuations and their inherent volatility within the foreign
exchange marketplace in relation to the activities of the macroeconomic environment. In other
words, we view uncertainty and volatility as advantageous profit drivers not as factors to be
avoided or antigens that erode a portfolio value over-time.

Our approach, the risks associated, and the pertinent economic indicators we are subject to are
unique within the foreign exchange marketplace are not correlated with stocks, bonds, or
commodities. Let us briefly explore the six macroeconomic disruptions we observed earlier and
associate them with our product and your portfolio positions.

1A. Global Supply Chain disruption – because we trade in currency, we do not wait for products
to be delivered in a supply chain, nor are we subject to backlogs or shipping delays, nor are our
trades tied to any underlying commodity asset or good distributed within the global supply chain.
Currency (money) supplies and their international distribution work on a completely different
and independent system from that of the global supply chain.

2A. Commodity Inflation - The increase in prices in commodities and overall consumer prices
while affecting many businesses, households, and most traditional portfolios, bear no effect to
our business model. When trading currencies, each trade is constructed by a pairing of two
currencies from two different countries. One country’s currency is bought while the other
country’s currency is sold. The profits generated in a currency trade are based on the difference
in pricing between the two country currencies in the pair. Because the current state of inflation

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on the economy is a global phenomenon shared to varying degree by all countries, the
commodity inflation is shared by both economies in a currency pair. The winning strategies that
we have developed over decades of trading experience remain viable in an inflationary market.

When trading currencies it isn’t necessarily the existence of inflation that concerns us, but more
so the inflation rate that is being experienced by the country of the currency we are buying versus
the inflation rate of the country currency we are selling within each traded pair. In other words,
we are completely indifferent to the global inflationary effects on prices because they generally
bear a net zero effect on our trading practices.

We are of course always prepared to make any adjustments necessary and always remain flexible
to respond in anyway necessary to an ever- evolving marketplace. However, overall the
fundamentals remain the same even in light of global commodity price increases.

3A. Liquidity Risks - The foreign exchange market has the advantage of being the largest and
most liquid marketplace in existence. The foreign exchange market is the largest financial market
in the world and is substantially larger even than the better-known stock or bond markets. Daily
trading volume in the foreign exchange market records a daily 6.6 trillion dollar volume as
opposed to stocks being a mere fraction of that; 200 billion per day! The foreign exchange market
is vast and is active therefore highly liquid.

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Furthermore, our trades are predominantly involved with the United States Dollar (USD) which
is the most traded currency and often referred to as the king of the foreign exchange market. To
put this into perspective, of the 6.6 trillion-dollar daily trading volume that encompasses the
foreign exchange market, the USD comprises approximately 85% of all transactions. Therefore,
we trade in the most liquid marketplace and trade
in the most liquid currency within that marketplace.
Because of this trading strategy we are able to
greatly mitigate any liquidity risks being that we are
always able to confidently enter and exit any trade
we take in a timely and efficient manner. This enables us to achieve our profit targets with each
trade and also preserve capital whenever a trade doesn’t go as planned.

4A. Counterparty Risk - is also a risk that our trading model is able to minimize. Being that our
trades are not comprised of contractual obligations, there is no risk of a party defaulting on their
obligation to any contract. A currency pairs trade is not a contract with obligations between two
parties to execute some list of responsibilities at a later date. A currency pairs trade is the
simultaneous buying and selling of two currencies instantaneously. The risk we bear has to do
with the narrowing or widening of the spread between the prices of the two currencies.

4A. Margin Risk – As mentioned earlier, trades in the foreign exchange market consists of buying
one currency and selling another. However, we do not take inventory or store the currencies
being bought. Nor are we selling off or depleting reserve amounts of currency being held or
stored in a vault. The currencies being “bought” and “sold” in a currency pair trade are in fact
not being physically traded at all. What we are trading are claims on specified quantities of
currencies not currency itself.

Because of this abstract nature associated with currency trading, using debt (margin) to sell a
currency that you don’t own is a necessary component. To minimize the risk of this margin we
implement a conservative approach when calculating the position sizing for each trade and we
operate using the most liquid of currencies (USD and six other “major” currencies) to make any

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costs of debt negligible. This approach is built upon our company wide philosophy of making
capital preservation our highest priority.

Capital preservation ensures that, regardless if an individual trade wins or loses, the overall
performance of the portfolio is able to maintain the lion share of its funding levels. The gains
that we are able to generate are the excess returns generated from successful spreads in pricing
of the pairs that we trade from very short term volatile fluctuations in the foreign exchange
marketplace.

5A. Bond Markets – The bond marketplace mostly operates independent of the foreign exchange
market. While both bonds and foreign exchange are affected by macroeconomic conditions the
key economic indicators associated between them are different. The industry wide factors that
affect the appreciation/depreciation of a country’s currency are identified as:

1. Higher interest rates in one country relative to interest rate in the other country involved
in the currency pair.
2. Lower inflation in one country relative to the inflation in the other country involved in the
currency pair.
3. A slower increase in income levels in one country relative to the increase in incomes in
the other country involved in the currency pair.
4. The comparative advantage in exports relative to the exports of the other country
involved in the currency pair.

6A. Currency Devaluation – It can be understood that with an increase in uncertainty, some may
express an uneasiness towards their outlook of the USD being able to maintain its current value.
This is understandable especially in light of seeing the wild devaluation swing of the Russian Ruble.

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We pride ourselves on remaining vigilant of the possibility of any currency devaluation in the
marketplace. To mitigate the risks of a devaluation crisis we choose to focus our trading strategies
on the seven “major” global currencies (USD, CAD, AUD, NZD, EUR, GBP, JPY) which possess both
the historical evidence of being the most stable and the most utilized in international financial
institutions, transactions and central banking. The Russian Ruble in the world of foreign exchange
trading is classified as an “exotic” currency. Hence, it is more prone to devaluation crises and we
avoid trading it.

In the graph displayed is a chart of the foreign reserves

held by all central banks internationally monitored by
the International Monetary Fund (IMF). Make sure to
take note how the USD comprises almost 63% of all
reserves worldwide. Also bear in mind that neither
Russia nor China, in spite of their immense geopolitical
impact on the world, have had miniscule impact on
global foreign exchange reserves; a chief indicator of
their currency importance in the global economy.

In a recent study in March 2022 the Bank of international Settlements (The Central Banks for
International Central Banks) outlined how the dominance of the USD was further solidified after
the recent Covid-19 pandemic and is expected to be maintained well into the future due to its
resiliency and robustness

Source: BIS Working Papers no. 783 “Dominant

Currency Debt”, Egemen Eren and Semyon
Malamud. March 28th 2022 Bank For
International Settlements..

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