August 19, 2022
Coronavirus will change how we operate for years to come…
COVID-19 and Currency Risk Management
Without a vaccine or remedy for COVID-19, any rebound in economic activity can be abruptly halted again. It is therefore crucial to learn the hard lessons from the first wave and integrate long-term changes into business and operating models to make them more resilient. This is especially true in the context of crisis and currency risk, where currency fluctuations driven by global uncertainty can severely impact internationally active businesses.
First, it’s essential to determine exactly where and how the crisis has impacted your existing models and, consequently, where the risks and opportunities lie within your value creation ecosystem. This allows companies to react swiftly to the inevitable changes we will continue to face in this unstable environment over the coming months.
The term "new normal" has been widely used recently. In the context of risk management, this "new normal" simply means we will continue to face extreme risk scenarios (“Tail Risk”) for some time.
The Current Environment Breeds Volatility
Trade wars between the U.S. and major economies, the oil price crash following the Russia/Saudi Arabia dispute, Canada’s rail blockades, and now a powerful exogenous shock like the coronavirus. Even with less, markets would have struggled.
In just a few days, we witnessed a complete reversal of economic and monetary policy. Central banks are back in emergency mode, while governments are scrambling to fund struggling sectors.
They must inject all the liquidity needed to prevent otherwise healthy businesses from going bankrupt. Interest rates are slashed across the board, and money supply is being expanded. The U.S. Federal Reserve has established currency swap lines with several central banks to ensure U.S. dollar availability and avoid an excessive appreciation of the global reserve currency.
The Coronavirus
Hygiene is now everyone’s focus. This pandemic is unprecedented in the type of uncertainty it generates and the associated social and economic impact. The closest comparison is the 2003 SARS outbreak, when risk aversion among investors led to sharp market declines.
However, the scale of this outbreak is far greater in both geographic reach and transmission. The truth is, no one knows the full scope of the problem. Markets hate uncertainty.
In short, governments still don’t know how widespread the virus is across America (and globally), and containment will take time. Widespread testing, quarantines, and “social distancing” have proven effective in curbing new cases, as seen in Hong Kong and South Korea.
The Impact on Currencies
Large parts of the economy—workplaces, schools, sports leagues, cultural venues, restaurants, gyms, retail—remain closed or severely restricted. A social safety net, even if temporary, is essential for people and businesses to pay their bills and sustain consumption. Social distancing will remain for a while. A recession is inevitable.
The Legacy
Every economic shock leaves a legacy. This time, it’s a public health crisis shaking the global economy. What kind of legacy can we expect?
Healthcare systems will be reorganized quickly, with more basic consultations shifting online to avoid infection risk in overcrowded clinics. Governments are likely to increase healthcare spending to prevent future crises from becoming as costly. Wealthier nations will need to help poorer ones. Fiscal deficits will widen.
Consumers will increasingly shop online, and remote work will gain ground among white-collar workers.
New regulations may enforce stricter cleaning standards in businesses, tighter border controls, expanded insurance coverage, and restructured travel logistics for both people and goods.
Global supply chains will undoubtedly be reconsidered, and business strategies will shift accordingly. This crisis once again highlights the risk of relying on a single supplier or manufacturing base—China, for instance.
The tradeoff between short-term efficiency (value creation) and long-term resilience will need rethinking. The “just-in-time” manufacturing approach is vulnerable to supply chain shocks and threatens long-term sustainability—a newly revealed “black swan.”
These changes will have lasting effects on production and distribution processes. Simplifying supply chains (e.g., sourcing components within Canada or North America) may eventually boost the Canadian economy, though it requires time and investment.
This list is far from exhaustive. The microeconomic impact of these adjustments will persist well beyond COVID-19. Hopefully, once the outbreak is contained—though not anytime soon—market values will begin to recover.
The Effects of a Strong U.S. Dollar
In the meantime, the U.S. dollar is gaining strength against all other currencies. Let’s remember: large moves in the reserve currency can send shockwaves through the global economy, especially for countries and companies with U.S.-denominated debt.
Moreover, in dollar terms, this appreciation leads to a decrease in global money supply, which conflicts with the need for more accommodative global monetary policy. That’s why central banks are intervening aggressively—to inject liquidity and expand money supply.
A strong U.S. dollar pushes the Canadian dollar down by 10 to 15 cents, jumping from 1.30 to 1.45 CAD/USD. The stability of exchange rates will be under great pressure in the coming months. Increased frequency and amplitude in currency movements are expected.
This depreciation offers Canadian exporters a significant pricing advantage—if they can find buyers across the border and have enough inventory to meet demand.
Navigating the Current Storm
Identify Major Costs and Revenues
If the goods you produce include imported components (assuming you can still obtain them), a weaker loonie’s benefit is offset by rising production costs.
Also, if you’re new to this market, time and investment are needed to establish logistics, develop clientele, and build customer relationships. The currency advantage may be gone by the time your product reaches the market.
A weak Canadian dollar helps manufacturers—but the reality is nuanced, with both pros and cons. Dissect these impacts to benefit from them.
Contact New Suppliers
Managing currency risk reactively is difficult. That’s why a clear policy that removes emotion from decision-making is essential.
The rapid fall of the loonie created potentially favorable conditions for Canadian manufacturers. But risks persist, and identifying and mitigating them is the best path to business continuity.
This is why companies must approach financial markets with preparation, not reaction. That’s the very purpose of a currency risk policy. FX risk management must be repositioned at the heart of operations—where risk enters, transforms, and exits the business.
Explore Currency Pass-Through Strategies
At the entry point, you manage margins and cash flows; at the exit, competitiveness and client relationships. Currency risk is complex, often invisible in financial statements, yet its impact is swift and unpredictable.
Align Your FX Position with Business Cycles
This organized approach protects against adverse currency movements while preserving operational flexibility. It helps reduce exposure to short-term trends and smooths currency impacts over the long term.
Proper risk management takes weeks and involves both internal and external resources—but it pays off quickly.
What to Do Right Now?
Here are a few suggestions to weather the current crisis:
A) Identify Major Costs and Revenues Over the Next 12 Months
- Understand the timing gap between costs and revenues
- Understand gaps between costs and revenues
- Quantify how a given currency fluctuation affects your margins
Determine the most effective FX positioning for the company:
- Reassess your residual risk (unhedged exposure)
- Identify the products or lines most at risk (and most profitable)
Set loss/profit triggers in advance—and stick to them. Consider forward contracts to lock in thresholds, and review your hedge ratio
B) Reach out to new suppliers with better pricing options based on their FX exposure.
C) Explore the possibility of passing currency fluctuations (partially or entirely) to clients or suppliers—without harming key relationships.
D) Synchronize your FX position with your operations and budget cycle.
Link FX fluctuations to operational efficiency and budgeting accuracy. Tracking costs at month-end is too late—act proactively
E) Step Back and Ask Critical Questions:
- How do we decide whether to hedge or not?
- Are we using all our internal hedging options?
- Are our hedging costs aligned with potential losses?
- What is the size of our unmanaged (residual) risk?
- Have our recent actions delivered the expected results?
- Are we over- or under-hedged?
- Is our coverage ratio adequate?
- What’s our distance from breakeven?
In the end, your business needs to know how much cash it will have in the coming days, weeks, and months—despite the velocity and severity of risk. This clarity is the foundation of your hedge ratio and maturity structure. Even in high uncertainty, a well-designed risk policy refocuses decision-making on protecting margins with clear action guidelines.
After the Recession Comes Recovery
As with every recession, the key is to endure. Some optimists predict recovery by June. I believe a gradual return to normal will begin by late summer, with true recovery around the holidays.
Ultimately, every crisis is also an opportunity. Now is the time for coordinated global action—interdependence at its finest. But tomorrow, countries and companies must find a new balance between globalization and protectionism, between interdependence and autonomy.
For more insight, read: Crisis and Currency Risk: U-Shaped or V-Shaped Economic Recovery? and Crisis and Currency Risk: Pandemic, Inflation, Market Volatility
And for deeper insight into the importance of currency risk management during uncertain times, refer to this article from the Bank of Canada.
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.