In today’s global business environment, few businesses are immune to the impact of the COVID-19 pandemic. Companies of all sizes are navigating the collapse of global economic activity and widespread repricing of financial assets. Actions by governments, central banks, investors, and others to manage the pandemic’s impact have created dynamic conditions in the currency markets.
As a result, “safe haven” currencies like the U.S. Dollar (USD), Japanese Yen (JPY), and Swiss Franc (CHF) have outperformed their peers. Conversely, many emerging market (EM) and commodity-sensitive currencies have lost value—in some cases, significantly. The Mexican Peso (MXN), Russian Ruble (RUB), Brazilian Real (BRL), and South African Rand (ZAR) are among the hardest hit.
Looking back, it’s hard to believe that 2020 began with a period of relative calm in the currency markets.
After months of calm, pandemic triggers volatile conditions
During the second half of the last decade, foreign exchange (FX) volatility took a downward trajectory, indicating more stable and predictable conditions. In fact, by the end of 2019, volatility in both major and EM currency pairs stood near decade-long lows. Since the onset of COVID-19, however, volatility levels have skyrocketed. While that volatility has retreated from record highs, levels remain elevated.
[Source for chart: Bloomberg]
Uncertainty in global markets is the primary driver of these fluctuations. Companies face a number of unpredictable conditions, from unforeseen supply chain disruptions to shifting consumer demand. These factors make it difficult—if not impossible—for businesses to develop reliable forecasts and move forward with confidence. In fact, citing the pandemic, a growing number of companies have declined to offer any quarterly guidance on earnings.
Finding opportunities and next steps
And yet, while the current environment presents unexpected hurdles, it may also provide opportunities. Companies with expenses denominated in EM currencies such as the Russian Ruble (RUB), Mexican Peso (MXN), or Indian Rupee (INR) have taken advantage of the outsized strength of the USD. Effective tactics include hedging a portion of anticipated exposures or increasing hedge tenors to capitalize on favorable interest rate differentials.
Other companies are helping their international customers deal with currency volatility by temporarily invoicing in local currencies rather than USD. While this flexibility does not eliminate currency risk, it can make it easier for customers to remit payment if their local currency has depreciated significantly against the USD.
Maintaining liquidity and adequate working capital has become a top priority for many firms. Where possible, companies have leveraged strength in currencies such as the Japanese Yen (JPY) to convert foreign currency balances to USD and maintain liquidity within their U.S.-based headquarters.
Repatriating cash is a final opportunity. Some businesses with funds in stronger currencies like the Japanese Yen (JPY) have converted these balances back to the USD and now are maintaining liquidity within their U.S.-based headquarters.
Moving forward amid dynamic conditions
As a finance professional or corporate risk manager, how can you navigate a volatile foreign currency market? Consider these points:
- Elevate visibility. Risk management decisions can extend to the most senior levels of the organization, often requiring C-level or even board approval on hedge strategies. With entire organizations navigating new requirements for business continuity and worker safety, it can be difficult to get currency risk on the radar. Garnering attention and support at the executive level should be a priority.
- Quantify your exposures. Next, identify where you have exposures and quantify the risk in each case. This simple advice can be far more difficult during periods of uncertainty, where conditions change rapidly and visibility into foreign operations and cash flows may be limited. Constructing a working financial analysis may be difficult, but it will help you accurately predict the true scope of your organization’s risk. As the old saying goes, you can’t manage what you can’t measure.
- Consult your bank. Comprehensive and up-to-date information yields stronger decisions. Here, your bank can be an excellent resource by providing robust economic analysis, intelligence about current market conditions, and information about accounting and risk management considerations specific to your situation. Frequent and open communication with your FX or risk management specialist will help you develop a suitable quantitative framework for decision making.
- Be flexible in your hedging strategy. In normal cycles, companies put hedging strategies in place for one-, two-, or even three-year periods, adjusting their approach only for major changes in business strategy. But with rapidly changing exposure forecasts, that practice may no longer apply. In fact, many companies now find themselves over-hedged. In the current climate, hedging instruments of shorter duration may be a better fit to mitigate risk.
- Consider options. A small bright spot lies in options, where prices have declined in recent weeks. As volatility levels decline, this could make options an effective risk management solution for certain types of exposures. Your FX provider can help you determine if an option strategy is appropriate for your situation.
Even as countries begin to loosen restrictions, it’s impossible to know how long it will take to contain COVID-19, re-open the global economy, and begin to reverse the contraction. Recent history offers only limited insights, due to the scale and scope of the current worldwide events. However, the pace of economic and financial market developments in 2020 seems accelerated compared to the slowdown of 2008-2009.
Regardless of speed, companies that pay close attention to their foreign currency exposures and create not just Plan A, but also Plans B, C, and D, will be better positioned to move quickly as market conditions dictate.