Insight to All Things Currency and Treasury Management

This blog post is based on my article “A Currency Superstorm is Coming: is your Organisation Prepared?” published on gtnews, Janurary 26, 2015. Read the article on gtnews.

The past few weeks have been a wild ride in the currency markets. The storm has been brewing for months, but rose to a new level on January 15.

On that day the Swiss National Bank (SNB) abruptly ended its longstanding policy of intervening in the market to limit the value of the Swiss franc (CHF) relative to the euro (EUR). Within hours of the announcement the CHF shot up 30%. The collateral damage was swift and has been significant; banks, brokers, and individual investors lost hundreds of millions of dollars.

A week later, the European Central Bank (ECB) announced a larger-than-expected bond-buying program in an effort to counter deflation and spur growth. The ECB plans to buy at least €1.1 trillion of assets, mostly government bonds. After the ECB announcement, the EUR fell to its lowest value against the US dollar (USD) since September 2003.

Significant global currency shocks are clearly not new. In mid-2012, the euro crisis had pundits suggesting that the EUR could fall to parity versus the USD. Later that year, Japan began its Abenomics program, dropping the value of the yen (JPY) 10% in just three months. On February 13, 2013, Venezuela announced that it would weaken its exchange rate by 32%. A year later, we saw the single biggest sell off in emerging market currencies since 2009. Finally in late 2014, Russia’s attempts to mollify currency markets only accelerated the run on the ruble (RUB).

While they are not new, the currency storms are intensifying. Many times, they begin with a central bank’s policy decision. Sometimes those decisions are ‘beggar-thy-neighbor’ competitive devaluation moves. However, often they are rational responses to domestic economic weakness (as with the ECB’s latest move, for example). At other times they are rational responses to the threat of weakness caused by another country’s monetary or economic policy.

Whatever the driver, a central bank’s policy decision creates fallout across currency markets. When the ripples from one central bank’s decision intersect with ripples from another central bank’s decision, they create a wave. It is like many smaller storms meeting at sea and creating a single superstorm. Furthermore, just as the weather has become more volatile – fluctuating between mild and extreme – so have the currency markets become more polar. For example, it was just this past summer that volatility in the currency markets reached near-record lows.

A Global Phenomenon

The phenomenon of intersecting currency storms is a byproduct of the highly globalized nature of financial markets today. Hot spots are everywhere. It is not only Switzerland and the European Union (EU) that are sending ripples through currency markets – the list includes Argentina, Brazil, Greece, Russia, Turkey, Vietnam and India – and doesn’t end there.

Nor do we see calmer waters on the horizon. Looking into the future, we are hearing an increasing number of pundits in the press and in the market talking about the possibility of China de-pegging the yuan (CNY) from the dollar. If that were to happen, the ripples caused would collide violently with those already coursing through the markets to create a true currency superstorm, which would be the big destabilizing event of 2015.

For multinational corporations (MNCs), currency volatility can be profoundly impactful both in the short term and the long run. Unfortunately, a multinational corporation’s ability to affect national monetary policy is limited. The good news is that there are crucial steps that we see smart companies take to prepare and mitigate the risk of a currency superstorm:

  1. Do more “What if?” planning: No one can predict currency markets but it is possible to use history as a guide for what could be in the future. Do robust scenario planning to see how your organization would be affected under certain exchange rate scenarios. Look at least six months into the future.
  2. Readjust how you’re stress testing and reporting: As you run “what if?” scenarios and use them to stress test your currency risk management program, use history as a guide. It has been known for companies to say that they use a 10% currency move as a stress test and a reporting threshold. In a world where currencies move two or three times that much, 10% is likely not high enough to be sufficiently useful in testing or reporting. Especially considering that the EUR has devalued by nearly 7.5% against the USD in the past eight weeks and the CHF moved 30% in a day – and even more during the trading session.
  3. The Currency RoundtableAdopt a currency roundtable approach: Currency risk impacts every functional area of the business, and decisions made by the business affect currency risk. Supply chain is one basic example. A US-based MNC sourcing product in the US to sell in Latin America, for example, would see its revenue eroded as LatAm currencies are devalued and the USD strengthens. So the supply chain function could take a strategic look at, for example, how different business decisions – sourcing from a different region, or asking suppliers to take payment in USD, for example – could help mitigate currency risk for the entire organization.
  4. Leverage big data analytics: They enable you to quickly get accurate, complete, and timely visibility into all of the currencies on which your organization is exposed, and what’s driving that exposure. Longer-term ‘what if?’ planning, more robust stress testing, and a currency roundtable approach all depend on your ability to see where you’re exposed and understand how business decisions affect those exposures.

During the euro crisis I wrote about the perfect currency storm. ‘Perfect’ currency storms are still raging all over the world and as they intersect, we are seeing hurricanes make landfall. Is your organization prepared?