Businesses typically reassess their currency hedging strategy around this time of year, whether it be annually, semi-annually or quarterly.
However, 2016 will be “potentially a difficult year” to protect against moving currencies, warn currency experts.
The year has barely begun, but it is bursting with volatility in financial markets, tumbling oil prices, central-bank surprises and rising geopolitical tension in the Middle East.
The world’s two major currencies – the US dollar and the euro – are making strong gains against the British pound, which is potentially bad news for UK multinational companies that declare their profits in sterling.
|Jeremy Cook, World First|
A weaker pound might be good news for exporters when it comes to repatriating foreign currencies into sterling, but the UK imports far more goods from other countries than it exports.
GBP/USD fell almost 10% from 1.54 at the start of November to 1.41 on Wednesday, and shows no sign of slowing down.
The Bank of England (BoE) was widely expected to announce its first interest-rate rise this year as the economy shows promising signs of growth, but BoE governor Mark Carney scotched expectations yesterday.
Furthermore, investors are now retreating from higher-yielding risky investments and instead flocking to the relative safe haven of the euro, says David Lamb, head of dealing at Irish forex provider Fexco.
“The euro is benefiting from anti-risk sentiment,” he says. “Investors are having to essentially unwind positions where [they were] short on euros and long on emerging market companies, because of the state of the global economy. Flows are going back into euro.”
The euro has strengthened more than 10% against the pound since mid-November, with EUR/GBP trading at 0.7707 today.
Market turbulence appears unlikely to die down soon, says Natasha Lala, managing director for solutions for business at retail forex broker Oanda.
|Natasha Lala, Oanda|
“In previous years, maybe one thing would happen that would create some volatility for a little while then taper off,” she says. “Right now, we are looking at three or four or five different threads.”
The US is racing ahead in raising interest rates, in stark contrast to the rest of the world, and China is experiencing an economic slowdown – both factors are contributing to market volatility and are unlikely to change soon.
Hedging is now becoming more popular with corporates, as is the desire for high-quality currency data, says Lala.
Jeremy Cook, chief economist at currency provider World First, says January has been a busy month so far as businesses look to the year ahead, and the fall in sterling has given “a bit of a kick” to those companies sitting on the fence unhedged.
“People are becoming more diversified,” he says. “[They are] not sticking to one forward contract, but are using different contracts and products to make sure they are getting what they want from their hedging profiles.”
No place for complacency
British small to medium-sized enterprises (SMEs) also worry about the impact of volatility, but appear to be surprisingly complacent, despite making £78 billion in annual international payments, according to the findings of a recent survey conducted by World First.
Almost half (47%) admit to ‘not really taking any notice of the currency markets’, but almost as many (45%) have been burnt by sudden movements in the past year. Cook warns that unhedged companies might suffer profit-margin issues this year.
The EU referendum is a looming source of further volatility. The UK has to decide by 2017 whether to stay in the European Union.
The referendum could happen later this year. The date has yet to be decided, but already three-quarters of UK SMEs that trade internationally fear currency volatility will impact their business.
“Companies are sitting with larger exposures than they would have,” he says. “In a lot of our conversations, our clients say ‘the cost of hedging has gone up so we don’t want to hedge everything because that’s too costly’.”
The rising cost can be attributed to derivatives regulation, such as the US Dodd-Frank Act and the European Market Infrastructure Regulation, and also simple supply-and-demand dynamics.
The more volatile markets are, the more expensive it is to purchase protection from banks and brokers in the form of derivatives.