The US Dollar Index, which tracks the dollar against other currencies, including the euro, pound, and yen, has soared 18% this year – a twenty-year high for the greenback. This is good news for American tourists planning a trip to Europe or elsewhere, meaning more spending in foreign currencies but not so much for businesses with global operations.
With market volatility increasing and investors concerned over a looming global recession, the dollar’s popularity rose as investors rushed to purchase more of the currency.
The dollar has traditionally been seen as a safe currency for investors outside the US. The Federal Reserve increased confidence through an aggressive campaign of interest rate hikes and capping the printing of more money to tackle inflation.
As the dollar increases in strength, many US companies which trade overseas are seeing a drop in their earnings, making it difficult to compete with firms in Europe and Asia.
IBM has warned that this could amount to a reduction of $3.5bn in their yearly revenue. Netflix has also suffered by not having an FX derivative to hedge foreign currency exposure; its losses due to the surging dollar have amounted to $339m in the second quarter of this year.
This highlights the importance of locking in rates ahead of buying and selling goods and services, which is now more critical than ever. Significant losses due to volatility and fluctuations in the value of currencies, in this case, the surging dollar, should raise the alarm for firms which ignore FX hedging.
Lack of help from traditional banks
To increase knowledge and expertise in FX hedging and currency risk, the first port of call for many businesses would be their bank. However, many are soon to find that traditional banks lack the right level of advice to support.
It is essential that all businesses, large or small, are aware of the actual costs and what the returns will be before each sale, even more so for smaller firms who trade across jurisdictions, as they could be at a loss before even doing business abroad.
Unfortunately, traditional banks can be unhelpful for businesses trying to understand their margins. The hedging tools provided often operate separately from a business’s payments and cash flow information. Businesses need access to all the info so hedging can become an integral part of their strategy.
Formal hedging programmes
Hedging programmes vary from business to business. However, the simplest is often the most popular. Companies who want to protect themselves from risk typically buy and sell forwards and options for certain currencies at a specific price on a particular date in the future. This helps companies to lock in protection.
Other hedging programmes can be more complex in structure, with some businesses looking to reduce the net cost further or increase the leverage. Most companies will hedge up to a few months, with long hedging being relatively rare, and it’s also standard not to hedge all the current budget. It is sensible to diversify risk, particularly as the currency market remains volatile.
If businesses take up formal hedging programmes, it is vital for them to be realistic and set short-term targets, focusing on areas which are likely to affect their business the most. Businesses should monitor their hedging strategies and be adaptable to change if circumstances determine.
How fintechs can help
It is important that hedging facilities are integrated with other services such as payments, cashflow, forecasting tools, FX hedging and risk management. This includes multi-currency accounts, which can help businesses to make payments in multiple currencies and allocate funds using virtual wallets.
Fintech firms have helped innovate these types of solutions, meaning that services previously offered by traditional banks can now form part of a single, integrated environment for the business user.
As the urgency for businesses to hedge remains, particularly as currency markets remain volatile with a strong dollar, alternative approaches offered by fintechs are enabling businesses to make that first crucial step into FX hedging. Through hedging on integrated platforms, businesses can get results and avoid the dramatic losses many businesses with global operations have faced with the surging dollar.
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About the Author: Laurent Descout is the Founder and CEO at NEO