Crisis and Currency Risk: The Impact of Inflation
Over the past two decades, many developed markets have experienced low and stable inflation—unlike the high-inflation decades of the 1970s and 1980s. However, inflation has recently re-emerged on the economic radar, creating new challenges for businesses navigating a context of crisis and currency risk. More and more countries are at risk of facing sustained price increases, potentially leading to more serious issues than previously anticipated.
Looking ahead to the next decade, it’s likely that policymakers will attempt to keep real interest rates relatively low to stimulate economic growth and gradually reduce high debt levels. But will they succeed?
Market Volatility and the Crisis in Currency Risk
The emergence of the Omicron variant came at a critical moment in the global economic recovery, just as central banks were considering raising the interest rates they had slashed at the start of the pandemic. What path will they choose?
Moreover, there is still little information on how governments will respond to this new variant. What restrictions will be imposed? Omicron adds yet another layer of uncertainty.
What direction should monetary and fiscal policy take in the wake of a seemingly never-ending pandemic and an unprecedented monetary easing that has lasted since 2008? Whether it’s about economic or public health policies, governments have struggled to establish a clear path forward. All these elements add to the growing macroeconomic uncertainty faced by businesses.
All SMEs face the unknown when expanding. Global economic fluctuations are part of that. However, lately, the importance of factors beyond their control has increased significantly.
The Economic and Operational Challenges Facing SMEs
Take, for instance, the foreign exchange market, where currency pairs can experience large price swings in short periods. Rising energy prices, the shift toward greener energy, global supply chain issues, evolving inflation trends, and diverging (or not) monetary policies among central banks—especially following Omicron—are bound to cause increased currency market volatility.
Currencies are especially sensitive to short-term interest rate changes, which remain firmly under central bank control. That’s why companies should monitor early signs of potential rate movements (or lack thereof), as these often indicate the likely direction of exchange rates.
A return to higher and more unstable inflation in major economies will likely trigger wider and more frequent swings in currency values—and eventually, depreciation in currencies from countries with the highest expected inflation.
Currently, the U.S. (1), the U.K., Canada, and Australia are showing the strongest signs of sustained inflation. Their currencies could weaken in nominal terms compared to those of European and Asian economies, where inflation remains moderate. However, in the event of a renewed pandemic surge (which seems to be unfolding), the USD may appreciate due to its safe-haven status.
Supply Chain Disruptions
Beyond broad market uncertainty, additional economic and operational challenges are making currency risk and liquidity management even more complex for businesses. Ongoing supply chain disruptions increase uncertainty in business operations (2), making it harder to forecast future cash flows (sales and costs) with confidence.
FX and liquidity hedging strategies must be reassessed more frequently (3). That’s why focusing on cash positioning—alongside enhanced FX hedge monitoring—is crucial. Ensuring the right amount of the right currency is available at the right time to meet client and supplier obligations helps maintain a solid liquidity position.
Currency Risk Management Strategies in Times of Crisis
In this environment of crisis and currency risk, your strategy must also be as simple as possible. Avoid hedge products with features that are not essential to protecting your cash flows (4). And never base your commercial decisions on market forecasts, which in such uncertain times, are little more than speculation.
Currency risk management must aim to protect your cash flows from any market movement—regardless of sector forecasts. Exchange rate shifts, supply chain disruptions, and market instability are now the only constants in today’s business environment. You must adapt to them.
From the budgeting phase onward, businesses should be able to simulate their various exposures to better prepare. Clearly identifying these risks upfront protects your profit margins and puts you in a better position to support business growth.
Ongoing changes in economic, political, and health conditions offer countless triggers that could quickly and significantly impact the markets. Treasurers must be able to frequently evaluate their currency positions and the company’s risk tolerance in light of changing profitability expectations.
When volatility causes major directional movements across currency pairs, it can lead to significant FX losses. But with proper exposure tracking in place, such currency effects can be anticipated and managed more effectively.
Ultimately, for SMEs operating internationally, the ability to monitor real-time currency exposure is a powerful advantage.
With few macroeconomic data releases scheduled over the holiday season—and lower trading volumes as Christmas approaches—market ranges are expected to remain “confined.” However, the evolution of the “Omicron story” could still cause breaks in the usual holiday range trading patterns.
- The US Consumer Price Index (CPI) reached 6.8% in November 2021—its highest level since 1982.
- See article: Crisis and Currency Risk: Coronavirus – What Now?
- See article: Currency Risk for SMEs - Plan for Recovery with an Effective Policy .
- See article: Currency Hedging Policy: Deciding to Hedge Factually
For more insights on currency risk management, read: Crisis and Currency Risk: Macroeconomic Perspectives on COVID-19 and that of the Bank of Canada – Currency Risk Management.
International Markets: A World of Opportunities
Growing your business internationally drives growth but also exposes SMEs to risks. Tracking how exchange rates affect performance is no easy task.
D-Risk FX provides SMEs with performance, risk, and scenario analyses by market, currency, and business line—leading to a tailored hedging strategy and real-time visibility on projected financial performance.
Gain autonomy, automate your processes, and approach foreign markets with the confidence of a clear currency risk strategy and the tracking tools to support your ambitions.