Although still expected to stay strong for the foreseeable future, the US dollar has weakened somewhat in the last few sessions, driven mainly by hopes of a pause in the Federal Reserve’s rate-hike campaign this year.
Since last week the PowerShares US Dollar Bullish Fund fell back to levels not seen since the middle of October, driven by the weakest non-manufacturing activity survey since February 2014. However, this might not be unusual as history has shown the USD often falls in the period following the first rate hike of a rising rate environment.
So should treasurers be ready for a weak dollar? They’ll as usual stay the course, not being currency traders. But what if further changes in circumstances reduces the USD’s strength? You build in flexibility. Of course, there are risks to the dollar outlook. US dollar current account deteriorations have halted dollar rallies in the past, some experts have noted; and the USD has rapidly gone from undervalued to overvalued according to commonly used valuation models.
With these risks to the outlook, it is prudent to allow more flexibility in the choice of instruments (options and option combinations over forwards) to protect the downside, while allowing upside whether the dollar rally reverses temporarily or not. Options are also beneficial when hedging acquisition deals that may or may not close, or in the case of bid-to-award risk.
Members of The NeuGroup’s T30-3, as well as others across multiple NeuGroups, aim to take advantage of any flexibility in current policies, even to pro-pose adjustments to policies to ensure stability. If hedge policies and strategies were designed during the dollar-weakening cycle, they may no longer produce the desired risk mitigation — which is indeed borne out by the continuing wave of reported FX losses in earnings releases over the past year — and should be reassessed. Among T30-3 members, two are in the process of considering instituting cash-flow hedge programs.
Again, most observers see the dollar keeping its strength for at least another couple years. Further, the Fed doesn’t see the dollar in the same way that the market does. According to Marc Chandler, Global Head of Currency Strategy at Brown Brothers Harriman, the Fed has “a nuanced understanding of the dollar.” On one hand, he writes in a note to clients, the share of exports in the US economy is relative small; for example they are less than half of that of Germany. “And much of what the US imports is invoiced in dollars, [so] the greenback’s exchange rate is not often a particularly important variable in the policy-making equation.”
Nonetheless it’s good to stay flexible.