How is the current world currency climate affecting importers and exporters, and what should they do to keep themselves above water? Mark Thompson, senior commercial dealer at Global Reach Partners explains.
The sovereign debt crisis and recent downgrade drama, combined with other world events, have undoubtedly had a major impact on importers and exporters. The US government debt, which has always been seen as the world’s safest asset has suddenly become riskier. When this is combined with events in Europe threatening the Euro, it poses great risks for manufacturers in Britain.
If history teaches us anything, it is to expect the unexpected, both in terms of unforeseen events and the solutions to combat them. Governments and central banks around the world have already pursued most traditional methods of fiscal stimulus to try and nurse their economies back to health. The European Central Bank, which controls interest rates in Europe and in effect is the glue that holds the Euro together, is currently in the process of buying Italian and Spanish government bonds. We are living through an extremely unusual era in terms of financial markets. Unsustainable debt first by banks and now by governments has created huge headaches for politicians and the banking system. The solutions to these problems are going to involve the use of new mechanisms and policies that the market has not yet priced in. For manufacturers this highlights the need to think carefully about their exposure to foreign exchange as economic shocks are likely to follow.
Major currencies and their relationships with various markets are experiencing a period of unprecedented change. At times like these we shouldn’t expect the foreign exchange market to act logically. Weakness in the Euro area doesn’t necessarily mean that the pound will appreciate against the Euro. British banks hold a large amount of European government debt and the UK sends 85% of its exports to Europe. So any default in Europe will have a knock on effect across the UK economy. Similarly, downward moves in the stock markets that traditionally cause the dollar to strengthen may not have the same effect this time. The downgrade of US debt means that the correlation between dollar strength and risk aversion is falling under intense scrutiny. When planning any export strategy, the old rules regarding moves in foreign exchange no longer apply. Adopting the right planning and risk management methodology will protect your business from any pitfalls that the market uncovers.
The upshot of this changing financial landscape is that volatility is back. The rate of change on the financial news agenda is uncommonly high and consequently we are seeing sharp intraday moves on all currency pairs. This obviously creates problems for any manufacturing finance department trying to plan with a degree of certainty. That said, there are ways of harnessing these volatile moves to your advantage, as long as you have protection in place you can benefit from this more capricious price action. Opportunities are available outside of the usual methodologies for managing foreign exchange risk. Options structures can allow importers and exporters to protect themselves and take advantage of positive movement. Businesses need to dedicate time to understanding these products as they are more complex than simply booking at spot or covering forward. This should be a discussion for you and your foreign exchange provider.
Looking at the broader effects on the economy brought on by the sovereign debt upheaval on either side of the Atlantic, the sad reality is that recession is looking more and more like a possibility. Lending will undoubtedly tighten. Businesses should expect credit conditions to worsen and financing will become more stringent and less widely available. Financial institutions that can only accept triple A rated bonds as collateral will have to reduce some of their loan book. Expect a trickle-down effect for business and consumers. It is now more important than ever for manufacturers to protect margins and act defensively.