That is not to say we won’t see also volatility from other currencies next year; that’s certain. Multinational corporations (MNCs) that have not learned how to limit the earnings per share (EPS) impact from currency volatility to less than $.01 will see their EPS eroded by currencies from all corners of the globe. However, the USD tops the list, because the likelihood of it strengthening in 2014 is much higher than weakening. An appreciating greenback will hit hard those MNCs that are unprepared for its revival, because while the dollar is unlikely to advance across the board it will strengthen against quite a few major currencies.
How will a strengthening dollar affect corporates that are not prepared? To answer that question, let’s go back 12 months to last December, when everyone was talking about the Japanese yen (JPY).
A Year of Yen Impacts
Before his election as prime minister for a second time at the end of 2012, Shinzo Abe promised to revitalise the long-stagnant Japanese economy, in part by ‘forcing’ the Bank of Japan (BoJ) to weaken the value of the yen. Abe won the election by a large margin and last December led the central bank to begin the competitive devaluation that is now regarded as the centerpiece of ‘Abenomics’. By several measures, the policies are working: since Abe’s election, the JPY has fallen some 25% against the USD and focused in around the ¥100=$1 mark.
The yen’s fall hit many US-based MNCs hard; among currencies that companies cited as impactful, the yen was the most cited in Q1 and Q2 of 2013 and the second-most cited in Q3. The reason why is twofold:
- A weaker yen makes the dollar relatively stronger, which makes US exports less competitive than Japanese exports in global markets. Indeed, devaluation has been a boon to Japanese companies; for example, in the six months to September 2013, 96% of Toyota’s operating profit increase was attributable to the JPY’s fall.
- A weak yen can also significantly impact MNCs that do business in JPY. Those deriving revenue from Japan – companies such as Varian Medical Systems, Nike and Procter & Gamble – receive relatively fewer dollars for their yen as the currency depreciates. Indeed, US companies across a range of industries have blamed the JPY for eroding revenue. On the other hand, those with expenses in Japan benefit by paying relatively fewer dollars for their JPY as the currency depreciates.
The Dollar’s Impending Rise
So the yen impacts that companies faced over the past year are a stark lesson in just how significant an effect currency volatility can have on corporations’ EPS; in 2013, the average EPS impact from currency volatility was $.03, three times the increasingly common industry benchmark of less than $.01 impact on the balance sheet.
Looking forward into 2014, corporates that have yet to take those lessons to heart will continue to see bottom line currency impacts. Where will those impacts come from in 2014? The answer is a strengthening USD.
The likelihood of USD appreciation is much greater than depreciation because:
- Following the appointment of Janet Yellen as the new head of the US Federal Reserve there are expectations of a moderately increase in the inflationary environment – the kind of environment that would result in rising interest rates and increased attractiveness of the USD. Furthermore, the Fed is poised to roll back its bond buying as soon as the economy appears healthy enough to grow on its own. While the Fed ‘kicked that can down the road’ this year, it cannot do so forever, and most signs point to the economy being healthy enough sometime in 2014.
- We are unlikely to see a stronger euro for some time. While it appears that Europe is emerging from its deep and long recession, the European Union (EU) is not out of the woods yet; if the euro strengthens significantly, that could stymie the modest momentum the economy has. So the European Central Bank (ECB) will probably do everything it can to keep the euro down.
- Similarly, forecasts call for continued weakness in the JPY. Prime minister Abe’s depreciation of the yen to drive Japanese export competitiveness, in an attempt to kick-start the economy, has worked well during the policy’s first year. The BoJ has articulated a goal of 2% inflation; currently Japan’s inflation rate is less than 1%, so achieving the stated goal will require further currency depreciation.
The impact of a stronger USD on corporations that are not prepared will be quite similar to the impact of JPY depreciation. Because fundamentally, the reasons why the USD is becoming relatively more expensive are not particularly important; whether it is Abenomics in Japan or a rollback of quantitative easing (QE) in the US, anything that results in USD appreciation will impact American MNCs, decreasing their export competitiveness and eroding USD revenues.
Rethinking Currency Risk Management
It took three quarters, but bottom line impact from the JPY has been so significant, and so sustained over the past year, that it has forced companies to finally rethink their currency risk management programmes. Investors have told chief financial officers (CFOs) that they don’t want to go through these kinds of losses again – and CFOs have passed the message on to their treasurers,
So how do treasury teams avoid history repeating itself? It will require an improvement in the way they approach currency risk management. If those companies that have suffered nearly US$12bn in losses during 2013 keep doing what they have done, they will continue to experience those kinds of impacts. If on, the other hand, they put in place a system that enables accurate, complete and timely (ACT) visibility into their exposures, they can keep impact from currency volatility from both the USD and other currencies to below $.01 EPS.
At the 2013 AFP annual conference in Las Vegas in late October, it was striking how dramatically our conversations have shifted from why corporates should manage currency risk across portfolio of currencies to how to do it. Awareness of the problem and the desire for a solution is clear, commencing with the understanding that you cannot properly solve the problem without ACT data.
So how to manage currency risk? Back in April this year the author shared the screen on CNBC’s Closing Bell with contributor Andy Busch. As the discussion turned to how corporates can manage EPS risk, Busch said, referring specifically to yen depreciation: “When you get a 25% move in less than four months, it really causes havoc for any kind of hedging capabilities that companies have. They just can’t adjust fast enough so you’re going to see a hit to their earnings.” My response was: “That is a thing of the past. Keeping currency impact to less than $.01 EPS is achievable today. There are companies doing it.”
Until the 1990s, it was true that managing currency risk across more than a few currency pairs was very difficult to do, as was responding to changing exposures on a very timely basis. However, that it is no longer the case. Today, with the right cloud-based technology, corporates can at the push of a button have full real-time visibility into their currency exposure – as well as the analytic capability to determine the best way to manage that risk. Many corporations do so today and therefore are able to achieve increasingly common benchmarks such as the impact from the balance sheet of less than $.01 EPS.
In other words, there is no reason anymore for corporates to not improve the management of currency risk – wherever it might come from.
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