Reacting to strong dollar headwinds that have stiffened lately, corporate FX managers are reviewing their hedging efforts to see if they are continuing to meet corporate objectives. They’re also looking into whether changes in program or objectives might be required in light of the reversal in a decade’s long cycle of dollar weakening.
This was just one of the featured topics at The NeuGroup’s FX Managers’ Peer Group 2 (FXMPG2), which met in mid-March to share thinking on how their FX management programs should respond a strong dollar.
As with several of its other peer groups, The NeuGroup has seen multinationals in these peer-leading membership forums taking steps to take advantage of policy flexibility or propose policy changes to allow for some combination of increased hedge ratios, tenor extensions to lock in attractive rates, or switching to another hedge instrument. The goal is to have a policy that works equally well in a dollar-weakening cycle as in a dollar-strengthening one; and that requires either flexibility in the “levers” of risk management (ratio, tenor, instrument) or the stomach for sustained periods of losses with a more rigid “no view” hedge program.
Message in a dollar
As has been seen in several corporate earnings reports this season, a strengthening dollar challenges foreign earnings and translated assets of USD-reporting companies. After seemingly years of weakness, which required little or no explanation to external stakeholders necessary (or desirable) as to how a weakening dollar benefited them, the dollar’s strength now requires proactive messaging and metrics to show that the underlying business is performing so investors don’t penalize the company’s stock unfairly for factors out of its control.
For example, one FXMPG2 member company added metrics on FX impact on EPS growth rate to its guidance messaging about a year ago, which has been well received by Wall Street. One reason was that the company has more international exposure than some of its competitors so it needs to be able to explain the difference FX makes in a way that resonates, comparing, for example, how EPS growth would have been affected if 2014 results had occurred at 2013 FX rates.
Where’s the dollar heading? Higher.
Eric Burroughs, an analyst from meeting sponsor Thomson Reuters and also editor of Reuters Buzz, gave a macro-economic overview and highlights on some key currency trends. First he noted that 2015 has delivered several macroeconomic and central bank surprises. The Swiss currency de-peg in January was “unlike anything we’ve seen in modern FX markets since the end of the Bretton Woods era,” and the Swiss central bank may adopt a Singapore-style FX management system along with negative interest rates. Oil-driven disinflation has prompted central bank easing “almost everywhere,” including rate cuts, asset purchases, and even negative rates. The ECB started its QE at the “earliest possible moment.”
What does it all mean? Likely sustained dollar strength, with the buck pushing the EUR/USD exchange below $1.00 and keep emerging market currencies under pressure. At the same time, EUR is starting to be treated like the JPY as a weak currency, with hedging of euro asset exposures leading to a stronger negative correlation between EUR and European equities.
The US’s sustained recovery will push the Fed and Janet Yellen towards lifting short-term interest rates up from near zero as early as June. While the Fed is sounding some concerns, it looks likely to tolerate a stronger dollar as long as the US labor market remains even or on an upward trajectory.