HEDGING CURRENCY RISK AS THE US PRESIDENTIAL ELECTION APPROACHES

Exchange rate swings have the power to seriously damage company cash flow and revenue, as evidenced on 18 March this year when the value of the British Pound dropped over 3 percent against the US Dollar to hit its lowest level in 35 years. Unfortunately, these days we are seeing a rise in the frequency of global risk events which have the power to destabilise currency markets, and those with foreign currency exposure are focusing on the potential for volatility caused by this November’s US presidential election.

For many financial officers, being caught out by such a swift movement on the currency markets isn’t just embarrassing – it’s costly! But it doesn’t have to be so risky; many firms relying on foreign income or earnings now use automated FX hedging solutions to minimise their exposure.

FUTURE RISK EVENT? WHAT COULD BE THE EFFECT ON FX MARKETS FROM THIS NOVEMBER’S US PRESIDENTIAL ELECTION?

On Tuesday 3 November American voters head to the polls to choose their president. Current polling indicates that incumbent President Trump is behind in the race, but with so many variables anything could change in the next three months. Risk managers are looking at different potential scenarios and assessing the extent to which they could impact currency markets. Potential outcomes include:

• A win for the Democratic Party. If progressive candidate Joe Biden secures a victory, Wall Street is concerned that his administration’s higher taxes would cause wealth creators to flee the US and damage the economy, although the Democrats insist any economic loss would be more than made up for by an expansion of the public sector. As such, some currency analysts believe that a Democratic win would weaken the US Dollar, at least in the short term.
• A win for the Republican Party. It is unclear how the US Dollar and other major currencies would be affected if Donald Trump cements a second term in office. Mr Trump would likely ramp up the trade war with China and elsewhere – which would under normal circumstances boost the strength of USD – but the US currency has recently demonstrated a bearish trend that could indicate it is losing some of its shine as a reserve currency.
• No clear winner. Another possibility is that there is no clear winner, or that the vote is contested. If Covid-19 related restrictions force voters to cast their ballots by post, and there are allegations of tampering (such as we have seen in the last two elections) we could potentially see a situation where a prolonged period of contention and uncertainty causes serious currency volatility.
• Election cancelled altogether. If the election is cancelled altogether or postponed for whatever reason, then volatility is likely to be amplified, with FX markets tracking political developments until the issue is resolved.

The US Dollar is generally expected to strengthen during times of domestic political uncertainty – but there have been two occasions when this did not hold true, namely the 2011 debt ceiling crisis and the 2016 general election.

What this all means is that traders simply don’t know to what extent the US election will cause currency volatility and must hedge the risk accordingly.

WHY ARE COMPANIES USING AUTOMATED CURRENCY SOLUTIONS TO HEDGE FX RISK?

Hedging against FX risk is critical for companies engaged in international trade and investments. But formulating a hedging strategy is not always straightforward. That’s why many companies are now choosing to make use of new automated tools that analyse cash flows to identify risk, and ‘role play’ different exchange rate scenarios.

Automated currency hedging systems are easy-to-use tool that allows CFOs to enter cash flow and earnings data in listed currencies and examine the potential impacts of different exchange rate movement scenarios. The software then provides a summary of risks, and advises on which hedging strategy (or strategies) would be appropriate to minimise it. This might be, for example, a Tapered Strategy (a high level of hedging in the short term and then a lower level in the long term) or a Constant Strategy (hedging at a constant rate of monthly exposure).

THE TIME TO PUT A HEDGING STRATEGY IN PLACE IS NOW

With just over three months until the US general election there is still time to put in place a strategy to minimise the risk of volatile exchange rates to your company. The fact is nobody knows the extent to which the election will impact currency markets, although it would be wise to analyse how a +/- 5% change in the value of USD (or whatever your main trading currency is) would impact your business.

Automated currency hedging tools can highlight the impact such a swing would have on your business and recommend appropriate hedging strategies, but if you’d like to talk it over with someone then why not give Currency Solutions a call and we can talk you through your currency transfer and risk reduction options.