Currency Volatility: Turbulence Ahead in the Foreign Exchange Market?

Understanding Currency Volatility

Foreign Exchange Risk Management Policy

The current geopolitical environment is a source of currency volatility. While the volatility of the six major currencies remains at historically low levels, emerging market currencies are already experiencing exceptional fluctuations! Is history repeating itself?

Factors Driving Currency Volatility

Trade Wars Between the U.S. and Major Economies

The protectionist stance of President Trump on trade could cause severe disruptions.

Political Instability in Europe

Angela Merkel's coalition government nearly collapsed in July.
A populist coalition in Italy promises tax cuts and increased spending.
Spain changed its government coalition without holding a new election.
What will happen with Brexit?

Despite these concerns and trade tensions:

Developed markets have not reacted significantly so far.
The foreign exchange market appears barely disturbed.
Volatility remains at near-historic lows for the six major currencies (AUD, GBP, EUR, JPY, CHF, CAD) against the USD.
However, the fluctuations in emerging market currencies tell a different story…

Impact of Currency Volatility on Businesses

Some emerging countries have seen their currencies collapse: a sign of future volatility?

The Argentine Peso and the Turkish Lira have plummeted.
The Brazilian Real and Russian Ruble have experienced substantial negative movements.
More recently, the Renminbi has started to decline, alongside the Colombian Peso and Indian Rupee.

Additionally, the U.S. Federal Reserve has signaled its intention to raise interest rates:

This could lead to further appreciation of the U.S. dollar.
It may also increase borrowing costs for loans denominated in U.S. dollars— impacting interest payments and principal repayments.

The current market situation bears an uncanny resemblance to the pre-1997 Asian crisis:

The depreciation of emerging market currencies and the rapid pace of these adjustments have significant consequences on global asset prices.
In 1997, the crisis was marked by the bursting of a series of asset bubbles financed by foreign debt (mainly USD) at low rates.
The 1997 crisis saw Asian currencies devalue, leading to a sharp drop across all currencies and up to a 50% decline in stock markets.

Strategies to Manage Foreign Exchange Risk

What does this mean for you?

Foreign exchange risk arises from fluctuations in currency prices. The stability of these prices will likely be tested in the coming months.
Companies with assets or commercial operations in foreign countries will face increasing risk. A rise in the magnitude and frequency of currency movements is expected.

What can you do about it?

Large corporations manage foreign exchange risks in various ways. However, you don’t need to be a multinational to hedge against currency risk.
Defining your exposure within a structured foreign exchange risk management policy is also accessible for SMEs. This shifts your approach from reactive to proactive, ensuring preparedness for market fluctuations.

The goal of a risk management policy is to identify, understand, measure, and mitigate the risks associated with currency fluctuations in your operating cycle.

Currency volatility can catch corporate treasury teams off guard. However, those equipped with proper tools and procedures can manage their risks effectively.
The first step in risk management is identifying what might hinder an organization’s ability to control its exposure.

Common challenges for treasury teams in managing currency risk include:

Lack of visibility on risk exposure within the company and unclear procedures.
Insufficient insight into underlying foreign exchange risks in financial data.
Inaccurate, incomplete, or untimely data.
Lack of transparency in foreign exchange risk management systems.

A well-defined foreign exchange risk management policy addresses all these areas:

Establishing clear processes simplifies risk management itself.
Understanding where risk enters, transforms, and exits your business within the operating cycle. Avoiding ad-hoc risk management decisions, removing emotion from the equation by providing clear guidelines for risk mitigation.

Developing a risk management strategy enables companies to:

Organize and structure relevant financial data.
Reduce exposure to currency risks.
Lower transaction costs.
Improve hedging performance.
Save time.

When planning for your business’s future, consider where you can gain the most value for the lowest investment:

Investing in a structured foreign exchange risk management process with D-Risk FX is cost-effective. The absence of such a strategy, however, can be extremely expensive.

D-Risk FX offers:

Knowledge transfer, providing expertise and confidence in managing currency exposure at a lower cost.
A strategic approach for treasury teams, allowing them to focus on high-value tasks.

For more information on market volatility, click here.

International Markets: A World of Opportunities

Expanding into foreign markets drives growth but also exposes SMEs to risks. Tracking the successive impacts of exchange rate fluctuations on anticipated business performance is particularly complex.

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.