Cash & Liquidity ManagementFXFX impacts expected to grow substantially

FX impacts expected to grow substantially

FX trading enters a volatile period as central bank turn on the financial spigot and uncertainty over how lockdowns will end

“The calm before the storm” is how Wolfgang Koester, senior strategist at Kyriba describes the FX market in the fourth quarter before coronavirus upended markets.

North American and European firms reported $8.9bn in currency headwind in the fourth quarter of 2019 according to a report released by Kyriba.

This was the third consecutive quarter during which negative currency impacts fell from their $26.7bn high in the first quarter of 2019. However, this still represented an earnings per share impact of three cents, higher than the industry’s benchmark of one cent.

“$8.9bn [in negative currency headwinds] was unfortunately, somewhat of a low number. I say that because I’m anticipating much larger problems and headwinds. The average S&P 500 company has over 50 percent of their exposure abroad, with that being spread over around 150 different currency pairs.”

At the end of last year, FX markets calmed, as China and the US made headway in overcoming their trade dispute. But now, with many governments pumping billions into their economies, Koester warns that we may start to see a ‘budget war’.

“What we’ve seen until this crisis is that the [US] has been in a trade war. In a trade war, what you want is your currency to be as low as possible. We’ve gone from a trade war to a budget war, where you want your currency as strong as possible.”

“Over the last few years, we have been used to a trade war and what I term ‘a race to the bottom’, instead we’re going to have a race to the top. The fundamental shift from trade war to budget war, will see continued volatility between global currencies, not just the dollar versus the other five major currencies.

High volatility

Shaun Osborne, managing director and chief currency strategist at Scotiabank points out that volatility has risen significantly, meaning any volatility-based hedging strategies are going to be more expensive.

“On the other hand, I think given that we have seen central banks react very aggressively to the growth challenges resulting from coronavirus, with most major central banks having pushed short term interest rates towards zero,” he says. “This has meant that interest rate differentials have shrunken quite significantly which has a big effect on forward pricing, particularly on the short end of the curve.”

As the scale of the crisis became more apparent, traders flocked to the ‘safe haven’ dollar. Osborne says the rush for dollars is reminiscent of what happened during the 2008 financial crisis.

“Initially in this current crisis the dollar has picked up. As we’ve seen in previous financial crises, like in 2008. We see something similar in the early stages of this pandemic with funding markets generally looking very tight. Banks were reluctant to lend to corporates, especially outside of the US, and holders of dollars tended to hold those dollars. There was a dearth in dollar funding in the offshore markets which spilled over into the US dollar and helped drive that initial surge in the dollar against most currencies.

In late March the value of the US dollar soared, rising to a 52 week high of 0.86 USD:GBP and 0.93 USD:EUR. From a longer-term perspective as the US Federal Reserve continues to add liquidity into the market Osborne expects the greenback to lose some strength.

“The willingness of the Fed to leverage its balance sheet and provide as much stimulus it feels the US economy will need to stabilise from this situation, implies to me that we’re going to see an even larger increase in the amount of dollar funding and dollar liquidity. Which is likely to have a negative impact on the US dollar.”




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