FX Predictions, Opportunities and Pitfalls in an Expanding Global Market
The July 2021 Kyriba Currency Impact Report clearly illustrates that corporate FX risk managers still have a challenging set of market conditions to navigate as the US dollar found footing against other currencies due to aggressive pandemic mitigation efforts and general business activity surging back to life. The combination of a resilient USD and increased business activity lead to significant negative currency impacts for North American-based firms. Consequently, European-based businesses saw less of a currency head wind from Q4 2020, but the impacts were still pronounced.
As we look forward to the full report of quantified currency impacts in the second quarter of 2021, we expect a similar if not elevated trend in negative impacts to continue. The global economy is expanding again, and as investor confidence returns, demonstrated by an influx of mergers and acquisitions, IPOs and SPACs the focus has moved away from cash visibility and real-time risk management towards accelerated business growth. This rampant business activity combined with a strong USD and general market uncertainty will drive increasing negative currency impacts for corporates on both sides of the Atlantic.
As we look beyond Q2 into the second half of 2021, with inflationary conditions expected to take hold in the US, uncertainty and impacts from USD volatility will trend as the most impactful to multi-nationals. In June, the US Federal Reserve increased its inflation forecast for the year and is signaling that it will raise interest rates earlier than expected. The combination of these two factors combined with other macroeconomic and geopolitical events indicates the USD, as well as other major market currencies will continue to follow an uncertain path through the second half of the year.
How are Corporate Risk Managers responding to the currency markets?
With the resurging business activity combined with currency market uncertainty, corporate risk managers are continuing to revisit their current capabilities. One factor, that is very top of mind for Treasurers and CFOs is continued digitization of their treasury and risk management platforms. One of the many drivers behind the digitization trend is the need to prepare for increased merger, acquisition, and divestiture activity. Smart treasury teams are moving very quickly to replace outdated and/or manual processes with Cloud-based solutions so they can quickly integrate acquired businesses into consolidated FX risk management programs.
Sophisticated FX Teams are closely monitoring the balancing act of risk reduction and the cost of hedging
With the expected movements by central banks to manage inflation through interest hikes, the cost of hedging will likely fluctuate significantly due to the changing interest rate differentials which have a direct impact on the cost of a hedge. As a result, FX teams are increasing their focus on more intelligent and cost-effective hedging. This includes examining hedging tenors, using automation to net currency trades in order to reduce the size and volume of currency hedges. Leading practices also call for conducting analyses using Value at Risk or Correlated Value at Risk combined with Cost-of-Carry efficient frontier models. These models enable risk managers to quickly and continuously optimize the tradeoffs between risk reduction objectives and the cost of hedging.
It’s clear based on the increasing impacts of foreign currency exchange in the Q1 2021 Kyriba Currency Impact Report that corporate risk managers need to stay focused and vigilant. Faster and more intelligent analysis will be central to navigating the continued market uncertainty and cloud-based FX exposure management platforms will provide the agility to keep up with the expanding business activity, mergers, acquisitions and divestitures. While the urgency to grow new business is more real than in recent history, having to report on FX impacts that are upwards of $0.01 to EPS is not acceptable and is avoidable.
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