To stay ahead, CFOs must adopt a customised and adaptable FX strategy that suits the current circumstances. Forward-thinking CFOs plan their currency management during calm periods, while their competitors are caught off guard when market volatility resurfaces
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Over the past two decades, the pace at which we live our lives has accelerated rapidly – from how quickly you can get a delivery from a Chinese manufacturer to the speed at which you hear about a company going bust in the US.
CFOs have spent a lot of time ensuring parts of their business keep pace with these changes – from investing in updates to their IT and Enterprise Resource Planning (ERP) systems to creating roles in emerging areas such as Artificial Intelligence.
However, many CFOs have failed to keep pace with the speed of changes that have taken place within the FX market. This is particularly concerning for those working for importers and exporters, who were caught on the back foot in 2022, particularly when the sterling crashed after UK prime minister Liz Truss and chancellor Kwasi Kwarteng announced unfunded tax cuts.
FX Options traders are constantly monitoring how the market is forecasting future movements in currency markets. Changes in implied volatility (see Chart 1) have a huge impact on the price of hedging instruments used by corporates to mitigate FX risk
According to The Economist, in the past year, the range of analysts’ expectations for American quarterly GDP growth has been twice as wide as in 2019. What’s more, it found the word “uncertainty” appeared more than 60 times in the IMF’s April Global Economic Outlook, about double as many as in April and October 2022.
What this boils down to is that forecasting is getting harder as volatility rises – creating headaches for CFOs. The speed at which people began moving their money during the recent US banking saga reflects how quickly news spreads and can impact financial markets in this age of the internet and social media.
A more volatile and more globalised world is a problem for many businesses, which are likely to have exposure to the changing prices of foreign currencies. We still see lots of CFOs and treasurers considering FX hedging far too late in the day.
When times (and rates) are good, they don’t look at their FX exposure. It is only when things become volatile do they realise, too late, that they should have.
There are so many more options available to corporates to help them with their FX currency risk management. A lot of flexible hedging solutions exist, from the very vanilla to the more bespoke. If you go back to the early 2000s, most corporates would simply hedge with forward contracts, or premium paid vanilla options, and this still prevails in many parts of the world.
The London corporate hedging environment is arguably the most advanced in the world – in part because the location demands trade with Europe, the West, the East, and Africa. These days, firms can protect their businesses from adverse movements in exchange rates while also retaining the ability to benefit from favourable moves. You can pay a premium to get maximum benefit or reduce the premium to get some of the benefit.
Many CFOs don’t realise the market has changed. It’s not about one solution at one time. As market volatility changes, so too does the attractiveness of FX hedging solutions in a corporate treasurer’s toolkit. There are solutions that work better in a high volatility environment and vice versa. At Investec, we look to ensure that all our corporate clients are kept abreast of significant shifts in the market. This is because tweaks to their FX strategy, to account for the changing conditions, could result in competitive gains.
With over half of 2023 already behind us, inflation and monetary policy continue to be the dominant themes in FX markets. However, this will change. Could 2024 be the year where political risk drives the market once more? The US and UK will most likely be in election years in 2024 and we can’t rule out the unexpected.
Whilst market volatility has quietened (at least for the time being), it doesn’t change the fact that our world and the pace of doing business has fundamentally sped up. This brings with it an inter-connected risk that creates opportunities for increased scale but also more complexities. A business needs to have an FX strategy that is bespoke, flexible, and fit for the times. CFOs that are ahead of the game will be doing their currency planning when things are quiet – leaving their competitors to scramble when market volatility returns.
