Insight to All Things Currency and Treasury Management

This blog post is an excerpt from my article “Treasurers Should Brace for FX Volatility in ‘Yuan Year’” published on AFP Online, December 15, 2015 discussing currency trends. 

The big currency story of 2016 will be one of yuan liberalization—and the very significant business risk it represents for global companies. But the yuan won’t be the only currency story.

Two currency predictions for 2016

#1: In 2016, currency volatility is no longer a “new normal” but rather just “normal.” And the associated business risks are a fact of life for multinational corporations.

As of Q3 2015, for the fourth quarter in a row, negative currency impacts to corporate earnings are magnitudes above the previous years’ averages, according to FiREapps’ analysis. Contrast this sustained volatility with the short-lived, two quarter spike of 2012’s euro crisis and we see that it is a different world now with all indications this trend will continue into 2016.

In 2016, hot spots might include the eurozone, Russia, Japan and Latin America.

The eurozone – Since mid-2014, U.S. multinationals cited the euro as a currency culprit as often as they’ve cited all other currencies combined. In 2015, the euro hit historic lows as concerns about the eurozone economies persisted, new geopolitical risks arose and monetary policy between the eurozone and the U.S. continues to diverge (ECB continues its pursuit of quantitative easing and the Fed is signaling tightening policy, with a rate hike on the horizon). Expect uncertainty, volatility and a weaker euro to continue. While a weaker euro tends to negatively impact U.S. corporates selling in Europe, it is volatility that makes planning such a challenge—and that volatility is likely to stay through 2016.

Russia – The ruble was incredibly volatile in 2015, rising 42 percent from a late-January low to a late-May high, then falling 25 percent to a late-August low. Multinationals like GM wrote hundreds of millions off cost of sales (in GM’s case, to the tune of $200 million). In 2016, Russia will continue to be a big question mark.

Japan – Though not nearly as much as the ruble, the yen was also volatile in 2015, bouncing between 118 and 126. I don’t see the yen strengthening next year; the Japanese economy fell back into recession, and most analysts predict that the Bank of Japan will respond as it has been—with more monetary stimulus that drives down the value of the yen. A weak yen has significantly weakened corporate revenue, and multinationals should prepare for more of that in 2016.

Latin America – The Brazilian real and Argentine peso continue to be volatile. In 2015 through November, the real was down 29 percent (it fell 17 percent in Q1 alone) and the peso was down 11.5 percent against the U.S. dollar. That volatility has impacted U.S. multinationals, particularly producers of ‘consumer products.’

Relative to those currencies and others, the U.S. dollar is likely to continue to strengthen in 2016. It has already been a driver of volatility, and the Fed hasn’t even begun to raise rates. Given the economic and geopolitical turmoil elsewhere in the world, the USD will continue to be the safe haven and create an environment where corporates have to operate under a mandate to innovate and focus on quality; not produce the cheapest export/product possible. For U.S. multinationals, that means more business risk.

#2: In 2016, China will further loosen its grip on the yuan, and that will increase business risk for many multinationals.

The Chinese yuan gets a prediction all to itself because of the magnitude of potential impact from that currency. Even though the renminbi (RMB) is a large exposure for many multinationals, many haven’t been actively managing RMB and the associated risks. For the first time in 2016, the RMB will be a risk that many multinationals will actively manage. So while Morgan Stanley is calling 2016 “Yen Year,” I think it’s far more likely to be “Yuan Year.”

On August 11, 2015, China surprised markets when it allowed the RMB to fall by nearly 2 percent. It continued to fall in days after, hitting a four-year low against the dollar. When China widened the RMB trading band, volatility increased among many Asia-Pacific currencies as other countries took action to attempt to maintain parity against the RMB. That tracks with what we’ve seen as the euro has weakened against the dollar—volatility in a major currency creates a ripple effect around the world.

In 2016, we see China widening the RMB trading band further. And contrary to years past, there is now a broadly shared sentiment that the RMB is over-valued and as China moves to a free float (one of the expectations of the International Monetary Fund (IMF)’s SDR currencies) the currency will likely depreciate further. At that point the volatility we’ve seen in 2015—and the associated business risk to corporates—will pale in comparison.