With the world on pause,
it’s a good time to think ahead to what comes next.
Some countries and states are starting to relax their strict lockdowns and open up for business again. With the coronavirus ebbing in some places and still spreading in others, the recovery will be uneven and jagged. Still, though, so much about the virus is unknown.
If anyone doubted the extent of economic globalization, it’s clear now how interdependent we are. That much is certain. We will undoubtedly see changes in mobility and international investment.
COVID-19 impact on global markets
As the COVID-19 pandemic spread across the globe, it created pandemonium in the global economy. Financial markets have been roiled, and day-to-day life has been upended. Most major markets cut interest rates to the bone to stabilize the markets, and stimulus packages are rolling out.
The largest and most liquid of the global markets, the foreign currency market, trades more than $6 trillion a day. It’s often called an “imperfect” market as not all participants have the same goals. Looking at the international community in a city like Los Angeles is an example of that imperfect market. Foreign nationals come to the U.S. for job opportunities; students come to study; importers are buying goods from abroad; investment firms seek to bring international investors into the fold as investors seek to diversify portfolios. Families and individuals seek to buy property around the world.
Movement in the market can be caused by a number of risk factors, including geopolitical instability. Even a hint of economic instability can send a country’s currency lower relative to another as investors seek safer havens. 2019 was a year of markedly low volatility, which initially appeared to be continuing into 2020.
Volatility has increased to levels not seen since the 2008
global financial crisis due to the pandemic.
Despite ups and downs this year, the U.S. dollar has remained relatively strong. The British pound hit a new low against the US dollar on 19 March amid coronavirus inaction fears, exacerbated by Brexit. The Canadian dollar has been hit by the oil double whammy as prices fell: first, the stand-off between Russia and Saudi Arabia in early March (which saw the dollar fall to a year-to-date low), and then the COVID-fueled reduction in demand that resulted in negative pricing in April. The Euro has languished as Italy and Spain locked down, and other countries followed suit. Brexit uncertainty has also weighed on the common currency.
Th
e relative strength of the US dollar
(the world’s reserve currency) makes the U.S. market an attractive destination for investment in many ways, even though the Federal Reserve has cut interest rates and has increased the money supply in response to the pandemic.
Thinking about your risk
The adage says that markets hate uncertainty, and the current situation magnifies uncertainty. It’s difficult to plan for the unknown.
In a volatile market, the “hope-and-pray” strategy isn’t typically a long-term winner. Evaluating your currency exposures and your future plans proactively can help stabilize and protect your investments.
Some questions you might ask yourself:
- What do my exposures look like relative to my initial expectations and target rates?
- Will my needs or goals change in the next three months? Six months? Twelve months?
- How much liquidity do I need? Can I wait this out, or do I need to repatriate funds?
- How do I service my commitments outside the U.S.?
As an example: expenses for property abroad or school fees may be constant and continuing, while other expenses may be more fluid. Returns on investments might be imminent or scheduled for a specific date in the future.
Currency risk management under quarantine
It’s not always possible to buy low and sell high in any market, and the currency market is notoriously hard to predict even in times of low volatility. But how can you protect your margins when the unexpected happens, and you’re selling low and buying high?
Depending on your goals and your position, there are a few different strategies you could explore.
Hedging tools.
From spot payments to rate orders to structured products, different tools that serve different needs, and risk appetites.
- Rate orders or limit orders allow you to set a target exchange rate for the purchase or sale of foreign currency. When the rate is reached, you will be notified, and you can execute the transaction. These can sit in the market for any length of time but usually are booked for two weeks.
- Forward contracts. A forward contract allows you to lock the exchange rate for incoming or outgoing funds for up to two years in the future. A flexible forward allows you to draw down over time; a standard forward commits you to a specific date. While a small deposit is typically required, a forward contract gives you certainty without tying up cash flow.
- Currency options. Unlike forward contracts, which commit you to the purchase or sale of the currency, options give you the right, but not the obligation, to execute a transaction at a given rate. Premium-priced options allow you to take advantage of upside movements while protecting on the downside. Zero-premium options can protect the downside but limit upside. This is a structured product and not suitable for everyone; consult your provider as to whether this makes sense for you.
Holding accounts.
Some providers offer multi-currency holding accounts, which allow you to send, receive, and hold different currencies in a single account, and payout or convert currencies when it makes business sense to do so. Some banks offer foreign-denominated accounts, usually requiring a deposit and a maintenance fee. Other providers offer the facility as part of their service. Don’t go it alone!
AFEX is a foreign exchange specialist:
we ALWAYS think it’s a good time to think about the foreign currency markets.
In addition to market insights, we offer a no-obligation trade audit and risk management consultation to evaluate your exposures, your risk appetite and guide you on managing risk and currency exposures. Please email David Runkle using the link below or call him at (818) 728-3298 for more information.
ABOUT AFEX
AFEX is a foreign exchange specialist, providing personalized solutions since 1979. We are a trusted business partner to more than 35,000 commercial and private clients around the world, facilitating payments in more than 100 currencies to more than 180 countries every day. Our solutions are cost-effective, strategic, and flexible.
