It’s been a big week for Europe, but for corporate leaders concerned about currency risk, the plan of action should be the same.
First up: Italy, where the constitutional referendum lost resoundingly. As he promised he would if the “No” vote won, Prime Minister Matteo Renzi stepped down. Both were largely seen as a victory for the anti-European Union third party. Expect significant uncertainty around Italy; as Simon Tilford, deputy director of the Centre for European Reform told Bloomberg, “Anything that causes doubt about political stability in Italy will unsettle investors.” Populists: 2. EU: 0.
The outcome was different in Austria, where voters rejected the far-right presidential candidate. The presidency in Austria is largely a ceremonial post, but the election is significant for what it might portend about the chances of far-right candidates in upcoming elections in France, Germany, and the Netherlands. Populists: 2. EU: 1.
The euro dropped against the dollar in early trading the day after the votes, but since regained its lost ground.
So there was no Brexit 2.0 this week, but investors remain wary – for good reason – about the outcomes of upcoming elections elsewhere in Europe. Germany and France, after all, make up half of the European Union’s GDP, and far-right candidates there remain contenders. (In other news, pro-European Union French President Francois Hollande announced that he will not seek reelection.)
While the value of the euro stayed relatively steady after the votes in Austria and Italy, its longer-term outlook remains questionable. Many analysts still forecast the euro reaching parity with the U.S. dollar in 2017. When the euro was first introduced, its value relative to the U.S. dollar was even lower. Given current economic conditions in the U.S. and Europe, a move toward parity seems more reasonable than 1.15 or 1.20.
Furthermore, all signs point to continued dollar strength. While some people express concern that a rising interest rate would cause uncertainty and therefore dollar declines, all of the business people we’ve spoken with express confidence in the U.S. economy, and if the economy is strong, any challenges posed by rising interest rates, from these historically very low levels, would likely be made up for by GDP growth.
A significant source of uncertainty into 2017 will continue to be China, where there has been a trend of currency devaluation. (It often surprises people to learn that the yuan has fallen about 15% relative to the dollar in the last two and a half years.) Underlying that trend is the fact that China continues to unpeg its currency from the U.S. dollar. That process won’t be complete overnight, but as it continues, the cost of hedging the yuan will rise accordingly.
What it all means for corporate leaders
At the end of the day, what this all means for corporate leaders is more uncertainty, and volatility – an environment in which it is increasingly difficult to ensure a margin without improving exposure measurement. Based on what we saw from corporations in their earnings calls post-Brexit, we would not be surprised to see more companies choose to further minimize currency impact disclosures. For investors, that means it will be riskier to invest in global corporates that choose to be less transparent. For corporate leaders, in means an opportunity to stand out by being transparent about currency exposure and improved results.
Currency risk is the largest manageable financial risk a multinational corporate faces. Corporates that can show investors what their currency risk is and how they’re managing it will be better positioned to earn investors’ trust, especially as some companies become less transparent about their currency exposure. As we head into uncharted territory, investors will be looking to see how corporates’ cash and cash flows are affected by currency risk, and how corporates have managed currency risk historically. After all, currency risk management is often a leading indicator for risk management across the business – corporates that excel in managing currency risk often manage their other risks well, too. There are many examples of small and large multinational corporations who do this very well and have improved their process recently to keep up with this increasingly uncertain environment.
How can a corporate leader get a handle on currency risk? A couple of points, which are explained in full detail in Corporate Leaders: An Uncertain World Demands a Different Response:
- By knowing all of their exposures and identifying their largest risks (which may not be their largest exposures)
- By working to improve cash flow forecast accuracy for managing currency risk to cash flow
- By communicating the cost associated with managing currency risk – and the risk associated with not managing it
- By extending currency awareness across the entire organization (it’s not just Treasury)
Votes in Europe this week delivered mixed news to global markets. But the plan of action remains the same: Corporates must prepare themselves to succeed despite continuing uncertainty and the currency volatility it creates.
Currency Crisis Q&A: The Practitioner’s Guide to Navigating the Next Crisis (on-demand webcast)