The U.S. dollar has taken a hit this year amid geopolitical tensions and the Trump administration’s failure to deliver on its campaign promises. The currency’s woes serve as a reminder of the need for companies that do business globally to manage the risks involved in their foreign exchange exposures.
As of Monday, the Bloomberg dollar index, which tracks the dollar’s performance against 10 other major currencies, closed at 91.875, down 10.1% from 102.21 at the end of 2016.
“The dollar’s been falling all year due to a declining optimism about Donald Trump’s growth agenda and also asynchronous global expansion,” said Karl Schamotta, director of global market strategy at Cambridge Global Payments in Toronto. As other countries’ economies pick up steam, “funds are flowing into the euro area and into the emerging markets—and out of the United States,” he said.
Schamotta said, though, that the dollar might head higher because so many market participants are now shorting the dollar in anticipation of additional weakness. “Currency markets are vulnerable to that correction; they’re just too lopsided.”
A dollar rally could be triggered by progress in Washington, D.C., on items like tax reform and fiscal stimulus, he said. “We don’t expect to see the dollar claw back many of its losses, but we could see a reversal in the next few months.”
Schamotta said the dollar’s moves this year also suggest that its role as a safe haven in times of instability has eroded. He noted that the recent rise in tensions with North Korea triggered a decline in the dollar’s value, rather than a rise.
“Your big safe havens today are the euro area, Japan, and Switzerland,” he said, citing the large international investments held by those areas as a stabilizing factor for their currencies. “The fact that they own more assets offshore than foreigners own onshore effectively means a run in the currency is very, very unlikely.”
From a fundamental standpoint, Schamotta argued, this year’s selloff left the U.S. currency more fairly valued than it had been. “In essence, what we saw over the last three years was something of an overshoot in valuation of dollar relative to other major counterparties,” he said.
The dollar’s weakness has benefited U.S. exporters and their overseas sales, but has crunched importers, especially companies that import from the euro area, he said. “Those that hedged themselves against the euro back when everyone thought the euro was going to parity, if not below, those who were prudent and had risk management programs in place, are much better off today.”
The Case for Hedging
Natasha Lala, managing director at Oanda Solutions for Business, said the direction of the dollar’s move should be less of a concern for corporates than the size of the move and the “high degree of volatility and unpredictability in the market right now.”
In addition to the factors that traditionally affect foreign exchange rates, such as interest rates, trade balances, and the state of the economy, “the wild card in all of this, and the challenge in predicting the dollar right now, is geopolitics,” Lala said. “There’s talk of a potential government shutdown, the crisis with North Korea—those are all having different impacts on the dollar.”
U.S. companies with foreign exchange exposures also have to consider the effect the dollar’s moves will have on other currencies, she said.
“So many companies have revenue and exposures that cross borders, they have to look at the whole picture,” Lala said. “As a U.S. company whose functional currency is U.S. dollars, you’re really exposed across the board.”
Companies that aren’t currently hedging have to start by getting a handle on their exposures, she said. “Having understood their exposures, they grapple with the question ‘How do we actually handle this?’”
Mitigating risks doesn’t necessarily require a company to do a transaction. Companies can offset FX exposures by “optimizing flows internally rather than paying a third party to make hedging trades,” Lala said. If there are exposures for which a company has no natural offsets, though, it has to decide whether to hedge, and if so, what portion of the exposure to hedge.
“You want to avoid being a speculator,” she added. “Just putting on a trade now, at a low point, expecting [the dollar] to go up, that’s a purely speculative trade.”
The Upside of the Dollar’s Slide
Amol Dhargalkar, a managing director at Chatham Financial, noted that many U.S. companies with overseas revenues are seeing the dollar’s weakness give their earnings a lift.
Chatham’s research shows that only about half of U.S. multinationals with significant FX exposures hedge those exposures. Dhargalkar said that a year ago, “when the dollar was strengthening, we saw a lot of companies actually getting worried. We saw a lot of companies actively engaged in putting together programs or reassessing their program.”
But after this year’s prolonged dollar weakness, “I’d say the predominant feeling right now for those corporates that didn’t put in place currency hedging programs is relief,” he said. “They’re not rushing at this point to put a program in place. They’re now getting a nice tailwind to their results to the extent that they have revenues from overseas.”
Dhargalkar said, though, that he’s not seeing companies with hedging programs in place pull back from those programs.
Companies “understand that the worst thing that you can do is turn on and off your hedging program because of the risk of buying high and selling low,” he said. “If they stopped hedging now, there’d be a decent risk that if the dollar went to the other direction, what was working for them now would stop working for the next cycle.”
Dhargalkar cited the outlook for corporate tax reform and the possibility of a repatriation tax as one current focus for U.S. corporates.
“That’s still a big question and has a potential to have an impact on companies changing their approaches,” he said. “Depending on how we do the territorial tax regime, that may have an impact on how companies have structured their entities’ intracompany flows and FX exposures. That’s just a big wild card.”