A week, they say, is a long time in politics – but last week seemed like an even longer one in financial markets. After a period of decline in the wake of Brexit, sterling suddenly rallied to a six-week high of 1.2598 against the dollar following Theresa May’s formal meeting with newly-installed US president Donald Trump.
While this is welcome news to investors, who will be hoping that further discussion of an improved UK/US trade deal continues to push the pound upwards, for global businesses exposed to dollar/sterling, the uptick provides some food for thought. The challenge arises if last week proves a sign of things to come; a regularly fluctuating pound against the dollar presents an accounting and forecasting headache for firms importing and exporting between the two countries.
More than seven months on from the UK’s historic vote to leave the European Union (EU), many British firms have got used to benefiting from the falling pound as goods have become cheaper to export. Although sterling has recently crept back up against the dollar, the truth is that until more clarity is provided on what Britain’s future trading relationship with Europe will look like, nobody knows what level sterling will be at from one day to the next.
With the unpredictability surrounding Trump’s direction of policy travel and Brexit negotiations front of mind, the only thing corporates can be sure of is that dollar/sterling is in for a bumpy ride. If this isn’t factored in from a risk management perspective, there could be negative consequences for corporates come month or quarter end when they close their books. Not only will group treasurers and financial directors across both regions have to forecast their revenues for the quarter, they will also have to budget for their hedging risk. Should the dollar-sterling rate continue to fluctuate, hedging risk may have to be assessed much more frequently.
The question businesses need to ask is by how much should they increase their hedging in order to make gains? Nobody is ever 100% hedged, but if sterling continues to experience sharp bounces against the dollar due to further comments from Trump, only to decline again due to Brexit uncertainty, treasurers have no choice but to increase their hedging ratios.
Approaches of course differ from business to business. For example, a FTSE-listed firm with large a corporate treasury team and highly sophisticated technologies is likely to be best placed. Corporate treasurers at small and mid-sized firms, on the other hand, need to first ensure that they have a reliable and accurate source of FX rates before they can even think about hedging. After all, these rates are only as good as the data at their disposal.
With further peaks and troughs to come over the weeks ahead, and with the price of sterling fluctuating almost daily, the last thing any corporate wants is to make financial transactions based on inaccurate data. Making decisions based on post-truth information might well be in vogue in politics, but it serves no place in the corporate world with financial execs under increasing pressure to keep bottom line costs low while looking for ways to increase top-line revenues.