2016 will go down as the Year of the Unexpected, as Brexit, Trump and the Chicago Cubs upended “likely outcomes.”
In that same vein, a liquidity crisis failed to emerge in the bond market, and the blockchain buzz still hasn’t died down. And if the path forward for financial markets wasn’t already uncertain, a Republican Washington now threatens to reverse laws and regulations that the industry has spent several years and billions of dollars adapting to.
Nevertheless, the outlook for capital markets participants is looking brighter. Volume-creating events have helped bank revenues improve, and we expect the trend to continue. Interest rates are finally rising, further aiding bank profits and benefiting the market as a whole.
Deregulation—or at least no new regulation—is likely to be the theme driving Washington for at least the coming year. And while the full impact of MiFID II still remains unknown, we’re hopeful the market will adapt throughout the implementation phase, leaving the markets more efficient but not over-regulated.
And on that positive note, here are our Top 10 market structure trends to watch for 2017.
Capital markets regulations are right-sized
Post-crisis Washington has been led until now by Democrats who believe more stringent capital markets regulations are the key to a safer and more efficient system. This perspective helped Dodd-Frank to pass and drove the subsequent agendas of the SEC and CFTC.
The majority view will change dramatically in 2017 via an atypical Republican president and a fully Republican Congress. Proposals that previously served as little more than sound bites must now be taken seriously, as Republicans finally have the votes to pass them.
We expect the Volcker Rule to be softened, Reg AT to be revamped if not killed, Reg NMS to be re-examined more closely than ever, and the move toward public reporting of U.S. Treasury trades to be slowed dramatically.
That said, we do not expect a repeal of Dodd-Frank and a full move to the right. Many of the changes brought about by Democratic-backed legislation are good, such as the move to central clearing, and the market would be damaged by a rollback.
But in addition to the aforementioned rule softening, do expect a less prescriptive and light-handed approach that should help reinvigorate market activity.
The Trump bump continues to help markets
The Friday before the U.S. election, the 10-year U.S. Treasury rate stood at 1.77%. Only two weeks later, the yield on 10-year U.S. Treasuries was up an astonishing 59 basis points and has risen even further since.
Increased government spending and lower taxes are expected to finally drive up inflation and along with it, interest rates—a good thing for the capital markets. Concerns over potential trade wars and immigration rules still exist, of course, but we’re hopeful that the checks and balance of Washington will alow only measured change.
While volatility is still mysteriously muted, volumes have picked up, supporting continued bank profits in various trading businesses—similar to the Brexit boost to bank earnings in 3Q 2016. Almost no one expected markets to get a Trump bump, but that seems to be exactly what’s happened.
ETFs keep growing despite eventual limits
The ETF market, and with it passive investing, will continue to grow in 2017. Robo advisors alongside the demand for cheap, liquid fixed-income exposure will act as major catalysts to increase ETF trading and assets under management.
In addition, ETFs are increasingly being viewed as derivative alternatives. Recent Greenwich Associates research finds that 50% of asset managers plan to replace some derivatives positions with ETFs in the coming year. Commissions on ETF trades, worth over $800 million in the U.S. in 2016, are set to grow further in 2017.
Despite the meteoric rise in popularity, however, passive investing has its limits. While seemingly still years off, so much money will have been pulled from active strategies that the opportunity to find alpha will reach a tipping point, and money will start to pour back in. To put it more simply, you may pass up a penny found on the street, but you’ll likely stop for a $20 bill.
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