CTC Forum Preview: Managing Multiple Currencies
- By Andrew Deichler
- Published: 2/1/2016
AFP: Can you talk a bit about your FX strategy amid the current market volatility? Are you changing anything up?
Gary Barth: We put on multiple-year hedges about two and a half years ago, and that took us out through 2017. We’re a big option shop here, but we’ve changed course over the last couple months. We’ve changed the way we look at hedging, to a more averaging-in type of approach, using forwards versus options. We’re gradually going to be getting into a rolling type of FX risk management. To take us from here to there, it’s still going to be multiple years, but it’s always going to be putting on hedges every month to get an averaging-in position. So we’re going to continue to use a combination of options, but with tighter strike prices, until we actually start using forwards.
AFP: As a big options trader, what is the implied volatility of the euro these days?
Barth: It’s definitely come in over the last couple months as the dollar has stabilized versus the euro. There was a big skewing—keep in mind that options are a combination of puts and calls—to buying puts versus calls. There was more volatility in the puts than there was in the calls. Today, that’s more balanced; there’s a little bit of a skewing for the puts versus the calls, but that’s come in fairly nicely.
But because of what Europe did with interest rates, that divergence has created an incredible opportunity to sell euros forward. And it’s the same thing with the puts. They’re less costly than they would be otherwise, because the forward curve is fairly dramatic. So right now, spot in euros is $1.0933. To go out three years, it’s at $1.1474. The further out you go, it really pays you to sell euros. Or, you’re buying the at-the-money put at $109.33 right now, spot would be basically five cents out of the money. It’s cheaper.
So there’s a skewing in the foreign exchange market, especially in euros, because of that forward curve. Either strategy will work really well for you. If you don’t have a position currently, going to the options market probably isn’t a bad way to go. But you have to start with deciding what you are trying to accomplish. You have to get everybody on the same page—the treasury department, the international group that has responsibility for the P&L for that particular business unit, and the CFO. Start with that, and then the mechanics of what instrument you actually use to accomplish that is the easy part.
AFP: What are your thoughts on China and the renminbi (RMB)? The RMB’s volatility has spilled over into other markets—does that concern you?
Barth: I love what the Chinese are trying to do. But they’re at a stage in their economic and market development where they’re going to make some mistakes. Now, the problem is, they’re not Guatemala. When the Chinese make mistakes, it has a dramatic effect. But you couldn’t really have expected anything other than that outcome, because when you go from a controlled economy to a market-based one, you get upsides and you get downsides. So they’re trying to manage that process, but you can’t have it both ways. That’s the whole idea of capital markets.
But what the Chinese haven’t fully appreciated yet, and I don’t know that our government has either, is that markets will self-correct. That’s the whole mechanism of markets. It may be painful, but they do self-correct. And if you don’t allow that process to happen—just look at the economic environment we’ve found ourselves in the last seven or eight years. It’s been below par, from a historical perspective. The Federal Reserve lowered interest rates down to zero and they just delayed the effect. They didn’t eliminate it; they just delayed it.
The Chinese are struggling with the same thing. They’re just newer to the game. The Fed has been around for a long time and you could make a very strong argument that their policy has failed. We won’t know until three to five years from now whether it fully failed or not. But there’s been a collapse ever since the Fed decided to move rates higher, and now they’re caught between a rock and a hard place.
Don’t miss Gary Barth’s session the CTC Corporate Treasurers Forum in May. More information is available here.
A longer version of this article will appear in an upcoming edition of AFP Exchange.
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