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Risk Management

FX and Interest Rates -- 1996

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March 13, 2015

Back in the 90s globalization was opening eyes to the connection between currencies and rates.

It seems so obvious today but about 20 years ago amid globalization, some people were just realizing the link between interest rates and foreign exchange. Nowadays it’s a given. In fact it’s one of the worries for the US Federal Reserve as it contemplates raising interest rates in the next several months. The US dollar is already at 12 year highs against the euro and many other currencies. A rate rise here could spike it even higher.

But in 1996, globalization was just beginning to show the link. “In looking to manage a firm’s currency risk, it is often a good idea to incorporate your view on interest rates,” we wrote in “Interest Rates &
FX Management” in the October 28, 1996 issue of International Treasurer. “Indeed, the practice of managing the net impact of fluctuations in both FX and interest rates on a given position or portfolio, not the impact of each in isolation, is often promoted to improve risk management.”

But treasurers were warned it wasn’t that straight forward, and essentially, the market will do what the market will do. For instance, as the 1996 story points out, “while rising rates can support a currency, falling rates may do so also.” The rate rise has to have a positive back-story in order for it make sense. “[I]f the rate reduction improves the country’s deficit financing burden, where interest rates have been historically high, a reduction can be equally good news for the currency.” So a little digging and due diligence is always in order.

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