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Insight to All Things Currency and Treasury Management

Like the parent who worries most when the kids are quiet, the good currency risk manager understands that the “quiet” period during the first few weeks of December often precedes a lot of activity in the last week of the year.

The quiet before the chaos

The last-minute activity comes in part from corporations scrambling to nail down their currency positions. Also, we have seen currency interventions from central banks, for a variety of reasons, during those last few days of the year. Sometimes, all of the activity leads to run-ups where a currency significantly strengthens or weakens.

In 2008, for example, the Brazilian real fell from 1.5645 at the end of July to 2.4386 the second week in December (a 56 percent change against the U.S. dollar). But in the last weeks in December, the real strengthened to 2.2660 (a 7 percent rise). In the 1980s, a period of significant exchange rate turmoil in Japan, the central bank took advantage of end-of-year illiquid markets to weaken the yen.

Despite the fact that the currency markets are relatively quiet now, there is good reason to believe that the end of 2012 could see surprise activity. There is a lot of uncertainty on both sides of the pond. In the U.S., no one’s quite sure whether policymakers will drive the economy off the fiscal cliff on January 1 and, if they do, the impact that will have. In the euro zone, we’re hearing comments about Spain and Italy that have already surprised the markets – something big may be in the works, or not. In Japan, the central bank may take advantage of the period of relative illiquidity to weaken the yen – or not. In China, the Communist Party’s new leaders may widen the band around the RMB exchange rate – or they may not.

There’s an acronym that fits the end of the year in the foreign exchange markets well: VUCA. It stands for:

Ÿ  Volatility: The nature, speed, volume, magnitude, and dynamics of change

Ÿ  Uncertainty: The lack of predictability of issues and events

Ÿ  Complexity: The confounding of issues and the chaos that surrounds any organization

Ÿ  Ambiguity: The haziness of reality and the mixed meanings of conditions

The term VUCA has its origins in the U.S. military at the end of the Cold War. The concept was developed to describe a new multilateral world where there was not just one enemy – a world in which the enemy could be anyone, and strike at any time.

How to thrive in a VUCA world

VUCA is a fact of life for corporations in today’s global world. So the goal is not to eliminate VUCA, but to manage it. When it comes to managing the volatility, uncertainty, complexity, and ambiguity associated with currency risks – especially at this time of year – the key is to be vigilant, to understand your currency exposure, and to stay in a solid defensive position.

The multinational corporations that will suffer currency-related impacts in a VUCA world are those that let their guard down. Don’t. Just because the currency markets are calm right now, doesn’t mean they’ll stay that way through the first of January. Storms are brewing everywhere, so make sure to square up your positions as close as possible to the end of the year.