With Q1 2017 quickly wrapping up, Trump and Brexit have dominated the currency markets for with all eyes firmly focused on sterling (GBP) and the dollar (USD). Even though these currencies have moved dramatically since last year’s unexpected political and economic incidents – and are key events for international businesses – it is important to look at the big picture and remember that all currencies are susceptible to drastic volatility.
It goes without saying that we should all remain attentive to the dollar and sterling as in light of Trump’s controversial presidency and the soon starting Brexit negotiations. However, these are not the only currency pairs in existence; and exposure can and will happen regardless of the pair. Now is definitely not the time for firms not exposed to the USD or GBP to get too comfy.
It’s not all about the dollar and pound
The currency market reaches far beyond USD and GBP. Given that Brexit negotiations are pointing more towards a departure from the single market for the UK, it would be advisable for Britain to start looking for business opportunities outside the eurozone. At the end of last year, British food exports outside of the EU surged by almost 20%, while exports to China also rose.
Exporting to new markets creates new opportunities that come hand in hand with currency risks. These hazards are more accentuated with emerging market currencies that can experience severe and extended volatile periods such as what we saw last year with the South African rand (ZAR) or the Mexican peso (MXN). These two currencies went through devaluations of more than 30% in a matter of several months, giving serious headaches to businesses exposed to them.
That said, we’re currently witnessing a positive reversal for emerging currencies. The MXN, previously crushed by the combination of low oil prices (Mexico is the 8th largest world producer) and Trump’s plans to remove the commercial relationship with its southern neighbour, is going through an unexpected 15% recovery in Q1 2017. This turnaround is no doubt in part fueled by the deterioration of Trump’s political potency.
Generally speaking, emerging currencies are recovering after a turbulent end to 2016. The ZAR is up more than 25% versus last year’s lows, and other emerging currencies, like the Korean won (KRW), the Russian rouble (RUB) and the Brazilian real (BRL) are distinctly moving upwards.
Stability, though, is not one of the features of these currencies and the market landscape can change fast; especially in uncertain times like our present one. After 40 years of international agreements and free trade, the world economic policy structures are being reshaped, triggering movements that, most likely, will amplify currency volatility.
The Chinese yuan (CNY) deserves our close attention. A series of devaluations triggered panic in the first quarter of 2016, but the renminbi (RMB) has remained under pressure practically ever since, forcing Chinese authorities to sell its FX reserves to keep the value of the yuan steady. The recent US dollar weakness coupled with Trump’s softer stance regarding the People’s Bank of China’s (PBOC) monetary policy helped eased tensions. However, we should not rule out further periods of turbulence until we see clear signs of an economic recovery in China, which does not seem to be around the corner.
The rest of 2017 looks is on course to be yet another challenging one for the European Union (EU), and, by extension, the euro. The Union will have to handle Brexit along with crucial national elections in France and Germany. Despite the rejection of the anti-EU Geert Wilders in the recent Dutch election, Marine Le Pen has serious chances to win in France. Her victory would put the EU in serious trouble, laying the groundwork for a perfect storm against the single currency.
For the sterling, until we know the specific terms of Brexit, the pound is likely to remain weak, and experience episodes of sharp volatility during exit negotiations. Only when the basics of the future relationship between the UK and the EU begin to take shape will investors shift their focus back to macroeconomic indicators which have so far shown an impressive resilience to Brexit-related uncertainty. The Bank of England (BoE) might also begin to consider monetary tightening action, which could bring limited relief to the GBP.
The dollar has also been on an unusual journey. Following Trump’s victory, it rose sharply amid high hopes that his tax reform and deregulation plans would boost the US economy, in turn forcing the Federal Reserve to accelerate its monetary tightening plans.
However, this enthusiasm has all but vanished. The failure of his health care reform undermined investor confidence in his ability to approve the fiscal spending plan to boost the economy, triggering a reversal that favours the euro and the yen over the greenback. Now, all eyes are on the Federal Reserve; if they give any signal towards softening their monetary normalisation path, dollar weakening could quickly accelerate.
Balancing opportunity with risk
There is clearly an opportunity for both businesses that operate outside of the EU and those that are looking to do so in the near-term. Theresa May has been encouraging UK companies to “get out into the wider world, to trade and do business all around the globe,” and that freeing itself from the single market will allow the UK “to increase its trade with the fastest growing export markets in the world significantly.”
UK exporters are experiencing a particularly fruitful time at the moment. The pound is near a 30-year low and there is a high demand from overseas customers for British-made products. However, it is vital to remember that currencies tend to be hyper-sensitive to uncertainties such as those lying ahead, and thus, business is likely to experience episodes of intense volatility. To balance opportunity with risk, those that are exposed to exchange rates need to embrace efficient FX risk management strategies to sail through turbulences without incurring any financial damage.
To implement this type of expert FX risk management must observe certain milestones starting with accurate exposure identification. In practice, this encompasses measuring the volume of exposure and determining which percentage of the company’s profit margins come from foreign currency-denominated sales. Armed with these numbers the company will be able to intelligently evaluate the costs of hedging versus the perils of unchecked exposure.
The next crucial step is choosing the most appropriate hedging tools. Which ones they choose will depend on the company’s unique requirements. Individually managing each currency is a drain on the finance team’s time and resources; a burden that can be immediately alieved with automation. Using automated techniques finance departments can handle all currencies as one entity using pre-defined business rules. This class of technological innovation represents a giant step for real time currency management; one that avoids wasting valuable resources on tedious and error-prone manual input.
There are many markets outside the boundaries of the EU that businesses are now moving towards. As the future trading relationships with the European Union become increasingly uncertain, companies can – and should – look to outside alternatives. However, to ensure that these new trading relationships are prosperous, it is imperative that business put into place sound FX strategies as to not get caught out by sudden FX swings. No currency is exempt from volatility, so when considering trading with new markets, a comprehensive FX risk management plan will be the foundation for success.
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