Omicron, inflation, political uncertainty, market volatility, supply chain
Updated: Apr 19
The past two decades have taken place against a backdrop of low and stable inflation in many developed markets as opposed to the periods of high inflation of the 1970s and 1980s.
However, in recent months now, inflation has resurfaced on the economic radar. Several countries are increasingly at risk of sustained price increases, and this could present more worrying issues than those considered so far. For the next decade ,policymakers willlikelyl seek to keep real interest rates relatively low, which would stimulate economic growth while gradually reducing high debt levels. But will they be able to?
In addition, the discovery of the omicron variant comes at a critical point in the economic recovery, at a time when some central banks are considering raising the interest rates they had reduced at the beginning of the pandemic. What will they do?
Moreover, there is currently too little information on how governments will react to this new variant. What restrictions will be put in place? Omicron, adds a new layer of uncertainty. What directions should be given to monetary and fiscal policies in the wake of a pandemic that seems to be never-ending and an unprecedented monetary easing that has lasted since 2008?
Whether it is economic affairs or public health, the establishment of a clear government direction on these issues seems hardly rising. What all of these issues have in common is that they increase the macroeconomic uncertainty that companies face. All SMEs have to face the unknown when growing. The risk associated with global economic fluctuations is one of them. On the other hand, for some time now, the importance of elements beyond their control has been growing rapidly.
For example, in the foreign exchange market, a market where all currency pairs can fall victim to large price fluctuations in a short time.
Indeed, the increase in energy prices, the rebalancing towards greener energies, global supply problems, the evolution of inflation and the implementation of divergent monetary policies (or not following Omicron) by the various central banks will necessarily produce greater fluctuations in the foreign exchange markets. In short, currencies are sensitive to changes in short-term interest rates and these remain firmly under the control of central banks. This is why we must look for any hint of a movement (or lack thereof) of the rate, because it is the latter that will indicate the direction of the rates.
The return of rising and less stable inflation in the major economies will therefore cause, in the first place, greater variations in the value of currencies both in amplitude and frequency and, ultimately, the depreciation of currencies in countries with the highest expected inflation. At the moment, it appears that the United States (1), the United Kingdom, Canada and Australia are showing the most signs of sustained inflation rising. Their currencies are expected to weaken in nominal terms against the currencies of the European and Asian economies, where the strength of inflation remains subdued. However, in the event of a strong return of the pandemic, and it is this scenario that seems most likely at the moment, the USD should appreciate given its safe-haven status.
Beyond the general level of market uncertainty, other economic and operational challenges add to the uncertainty and complexity of managing the company's foreign exchange risk and liquidity.
Supply chain disruptions increase uncertainty in business operations (2). As a result, forecasting cash flows (sales and costs) is more difficult and uncertain.
Revisions to exchange rate and liquidity hedging requirements need to be even more frequent (3).
Thus, refocusing on the cash position with increased surveillance of currency hedging is critical. Ensuring you have the right amount in the right currency at the right time to cover payments from customers and suppliers helps maintain a strong liquidity position.
Your strategy should also be as simple as possible. Avoid hedging products that contain features you don't absolutely need to protect your cash flow (4). Above all, do not base your business decisions on market forecasts which, in these circumstances, are little more than conjecture.
Currency risk management should focus on protecting your cash flows from any market movement, regardless of the various forecasts of industry players as exchange rate developments, supply chain disruptions and market instability have become the only constants in today's business climate. You have to adjust to that.
As soon as the budget is built, the company must be able to script its various expositions to better understand them. This ability to position your risks clearly, from the start, will not only protect your profit margins, but also put you in a better position to support your growth.
Economic, political and health news offer many catalysts that can quickly and substantially change the markets: The treasurer must be able to frequently assess his market positions and the company's risk tolerance in the face of changing profitability potential.
When volatility creates large directional movements on various currency pairs, it can lead to large foreign exchange losses. With proper monitoring of your exposures on a RTBD (Remain To Be Done) basis, these currency effects can be anticipated and better controlled.
Ultimately, for an SME operating internationally, being able to monitor the evolution of its residual currency exposure in real time is a significant advantage.
With little release of macroeconomic data on the holiday calendar, and the reduction in volumes traded in the run-up to Christmas, trading ranges are expected to remain "confined"; however, the evolution of the "Omicron story" could lead to breaks in the usual "range trading" of the holiday season.
1 The Consumer Price Index (CPI) in the United States is at 6.8% (Nov. 2021). Strongest bull since 1982
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