Relatively calm conditions in the foreign exchange markets over recent months and the robust performance of the US dollar have persuaded some American multinationals to scale back their hedging activities for guarding against currency volatility, reports Reuters.
Volatility is at a five-year low thanks to muted price moves across all asset classes, relatively benign economic data and a lack of big divergence in monetary policies around the globe. These have combined to dampen currency turbulence as measured by the Deutsche Bank FX Volatility Index.
This is offset by data from corporate treasury and cash management solution provider Kyriba, showing that North American companies reported $20.84 billion in negative currency impacts in Q4 2018 – the most since Q4 2015.
“If you look at periods of distress like the financial crises, the internet bust, the Greek debt crises or Brexit, those are always times when banks see a rapid pickup in hedging activity by their clients,” Mark Wendling, senior managing partner at Bannockburn Global Forex tells the agency.
“With the lower volatility that we have seen in FX recently, some customers do get lulled to sleep and hedging activity drops.”
A strong greenback
Calmer conditions have seen a reduced use of strategies including forwards and options to guard against currency moves by US companies that generate a large part of their sales overseas. This has been added to by the continuing strength of the US dollar, which rose by 6.2% on a trade-weighted basis in Q1 of 2019 from a year ago.
Low FX volatility, which makes for relatively cheaper options prices, and increased one-off demand for hedges due to a substantial pickup in deal-making this year, should have boosted corporate hedging activity, currency strategists told Reuters.
Instead, FX corporate hedging flow from US multinationals has been notably lighter than expected, said Andrew Scott, head of flow strategy and solutions at Société Générale in New York. “For those hedging incoming non-dollar revenue streams, one plausible argument is perhaps the fact that no one actually quite believes that this dollar strength is sustainable,” said Scott.
A strengthening dollar is usually a negative for US multinationals, whose foreign currency revenues are then worth less. While some companies have well-defined systematic approaches to FX hedging, others employ substantial discretion, analysts said.
Companies frequently have pre-set hedge ratios but still have some room to manoeuvre within those ranges, said Chuck Brobst, managing director at OANDA Treasury & Analytics. “Their strategy might require them to hedge 60% to 80% of next year’s foreign sales. Within that range, they have discretion of how much to hedge, so during periods of low volatility in currency markets, they act with less urgency, and remain less hedged,” he noted.
“At the margin, when volatility is low, more corporates are prone to take a directional view and wait to see which way the market breaks.”
Staying on the sidelines
An unidentified trader told Reuters that hedging activity has stalled in recent months, with clients unwilling to take a bet on currency movements due to uncertainty about how long-running political conflicts will develop.
US-China trade tensions uncertainty about the outcome of the UK’s efforts to leave the European Union and the potential impact on oil prices from the political crisis in Venezuela are keeping clients on the sidelines. However, volatility can return fast and this week markets have been unsettled by worries that Washington and Beijing could fail to reach a trade deal.
While interest in FX hedging has risen in general as companies grow and do more international business, there is room for activity to pick up once FX markets get choppier, said Amanda Breslin, head of Chatham Financial’s corporate treasury advisory group.
“There’s usually a little bit of a time lag from the time volatility spikes to the time corporates are actually feeling it flow through to their financials, getting heightened sensitivity from their board and then having a much shorter time frame to implement a solution or at least a go-forward risk reduction program,” she told Reuters. That delay could impact on company results.
“Currencies can trend and still have low FX volatility,” said Amo Sahota, director at FX risk management consultancy Klarity.“You see the low volatility and think I am not going to do anything about it, but it’s like death by a thousand cuts.”
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