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FX Volatility May Require Treasurers to Get Creative

  • By Andrew Deichler
  • Published: 9/25/2015

HedgeCOPENHAGEN, Denmark -- The negative impact of currency volatility on multinational corporations in recent months has been staggering , and there is little doubt that currency fluctuations are top-of-mind for treasury professionals. During a session at the EuroFinance International Cash and Treasury Management conference, analysts attempted to determine what the current state of the currency markets could mean for treasurers in the long run. 

Eric Burroughs, editor for Reuters Buzz and The Dealing Room, noted that currency volatility as a whole is not going away. The euro, which has been stronger in recent weeks, will likely weaken in the long term as the European Central Bank is expected to extend quantitative easing. “The ECB is not comfortable with the euro’s strength of late; it has certainly tightened financial conditions,” he said. “So it will lean against that strength because it wants a weaker euro to help the economy.”

Meanwhile, the U.S. dollar has remained strong . While conventional logic would tell you that this is a problem for U.S. multinationals, the U.S. economy is actually doing relatively well compared to the rest of the world, noted Burroughs. So if and when the Federal Reserve raises interest rates, that USD strength is likely to continue and also impact the euro.

China and the emerging markets as well will have an impact on the euro, Burroughs added. “We’ve seen quite a big decline in reserves as they’ve devalued currencies or kept their currencies stable, and that reserve strength has an impact on the euro,” he said. “Even though they’re selling dollars in most cases in that process, the big drop in their reserves also means they have to sell euros to keep the ratio of reserves and allocations balanced.”

One thing that hasn’t garnered much attention, Burroughs added, is how similar the euro is to the Japanese yen. Because of the negative interest rates in Europe and quantitative easing, a lot of investors are hedging their euro assets. “Therefore, there’s a very strong negative correlation that’s developed, most clearly seen in the equity market,” he said. “If the equity markets go up, the euro goes down, and vice versa, which is the way the yen has been for the past 10 to 20 years.”

Burroughs concluded that with the euro in decline, one-year forwards are not always going to be the answer for treasurers. “I think corporate treasurers are going to have to be a bit more creative about using options and other strategies when hedging their currency risk,” he said.

Sebastian di Paola, partner and head of the global treasury consulting practice at PwC, commented that FX risk management is a “core building block” of the treasury function. Treasurers he has spoken with are generally split on their hedging policies, with some favoring dynamic programs and others preferring static ones.

Di Paola noted that given the volatility in the currency markets, treasurers should always have a view into their exposures.  “It’s really about making sure that you have the right governance around whatever it is that you decide to do,” he said. “I don’t think that, as a treasurer, you want to be the one left carrying the can, whether your view is right or wrong.”

Di Paola added while treasurers need the right tools to provide such a view, many of them are being pressured by their banking partners to use more complex products than they actually need. “I think the complexity lies in the exposure,” he said. “We should invest more effort in understanding price elasticity of our exposures before we start worrying about complicated instruments.”

Having said that, di Paola agreed that some organizations may opt to use more option-based structures rather than the “vanilla” forwards that most companies are using. “But I would expect an FX risk management policy to say that we shouldn’t, as a company, be entering into instruments that we can’t independently value,” he said. 

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