Expected Events with Fairly Predictable Currency Impacts

Democrats' takeover of the U.S. House of Representatives.  The recent results of the midterm elections are certain to impact the U.S. dollar (USD) in 2019, and in some fairly predictable ways. With a divided House and Senate, U.S. markets will be more sensitive to swings in the political climate. Additional tax cuts—which sparked a rise in the dollar in 2018—aren't as likely in the new era of divided governance. The White House may also have more difficulty in 2019 getting Congressional support for its call for additional economic expansion, which was another driver of the dollar's rise last year. Thus, many market watchers expect the dollar to weaken throughout 2019.

The looming Brexit deadline.  As the March 29 Brexit deadline draws nearer with no approved exit plan in place, uncertainty continues to grow. Even if Brexit is delayed beyond March 2019 and the United Kingdom strikes a deal to temporarily remain in the EU single market, the British pound (GBP) is expected to continue to fall against the euro and USD.

Recent talks of Britain's ability to withdraw its Brexit notice could change this. If Brexit is reversed, investor concerns will be eased, most likely leading to a spike in the GBP.

Italy's budget crisis.  After having its 2019 budget rejected by the EU, Italy continues to push for additional spending that would increase the country's debt. This rift within the EU adds to the uncertainty of the euro. Volatility is sure to ensue in 2019, as Italy deepens its debt, placing a financial burden on other member states.

The impending end of Merkel's reign.  After German Chancellor Angela Merkel's October announcement that she will not seek re-election, the euro slipped against the USD as investors and the general public questioned who will replace her. The longest-serving leader in the European Union, Merkel made the announcement at a time when the EU's future is unclear amid the U.K.'s exit date and the Italian turmoil.

With so many EU-based political events culminating in 2019, it's reasonable to expect the euro to be quite volatile this year. In particular, Merkel's decision to step down is expected to have negative impacts on the euro, since Germany is a dominant player in the Eurozone.

The fragility of Middle East stability, and a spotlight on Saudi Arabia.  The United States' withdrawal from the Iran nuclear deal and recent reinstatement of sanctions against that country have added to Iran's mounting economic challenges, which will likely further impact the already depreciating Iranian rial (IRR).

But Iran isn't the only Middle Eastern country battling events that could greatly impact its currency in 2019. Saudi Arabia is managing growing concerns over its political stability following the death of exiled Saudi journalist Jamal Khashoggi. U.S. senators have backed a resolution to end support for the Saudi-led war in Yemen, which would effectively cripple the U.S.-Saudi relationship. Because the majority of Middle East currencies are tied to the U.S. dollar, they will likely move up and down with the USD and in direct negative correlation to the euro.

Expected Events with Unpredictable Currency Impacts

The introduction of a digital dollar.  The United States is working toward the adoption of a crypto-dollar. Goldman Sachs and other large financial services companies are now backing startups that are working to roll out a digital version of the USD pegged to the currency. These firms' support for the idea suggests it is only a matter of time until the crypto-dollar is a reality. In fact, this new digital currency may very well be introduced in 2019. If it is, it would have material impacts on the currency market—but what those effects would be are anybody's guess.

Digitalization of financial institutions around the world.  This year, financial institutions and governments will take large leaps toward global digitalization. Both banks and governments are rethinking how they interact with consumers and businesses, increasingly turning to the digital stage and focusing on the move toward digital currencies and technologies that prioritize digital transactions with consumers.

The cost structure of most banks today is not sustainable if payments and other business interactions are carried out digitally. Traditional institutions with physical locations have higher operating costs and more overhead compared with digital-first businesses. And digital-focused financial services firms often pass these savings on to consumers, taking them off the hook for minimum balances and charges such as direct deposit fees.

The move toward digitalization is making traditional banks less and less competitive in comparison with those institutions and governments that are investing in technology. This means the landscape is changing for the ways in which companies interact with their banks. As this happens, the move toward digitalization could impact currency valuations, counterparty risks, and payment structure.

Fundamentally, the antiquated process for global cash transfers has always created a risk, as most transactions are settled within two business days. Digitalization removes that and the associated counterparty risk from the equation.

Currency valuation impact comes into play as global currency leaders with liquidity race to release a digital currency. If, for example, Japan comes out with a digital currency 12 to 18 months before the United States, there would likely be a shift in value toward the yen.

Such disruptions will impact the financial markets in ways we can't anticipate. They will likely create volatility in currency markets, but we have no sure way of knowing when that volatility will occur or how corporations will be impacted.

Unknown Unknowns: A Few Possibilities that Could Have Unpredictable Market Effects

The killing of influential people.  A Turkish court has accepted an indictment for the 2016 assassination of a Russian ambassador. More recently, Jamal Khashoggi's death sparked international outrage toward Saudi Arabia, and a nerve-agent attack in Salisbury, England, on a former Russian spy and his daughter led to EU and U.S. sanctions against Russia.

These events beg the question: When and where will the next politically motivated assassination (or attempted assassination) happen? Such attacks on influential figures will probably continue. And each new incident has an impact on international relations—and, consequently, on the currency markets. However, because we have no way to predict future actions that will lead to international outrage, we have no way to determine the effects those actions will have, or the level of volatility they will create in specific currencies.

The trade war between the U.S. and China.  The U.S.–China trade war has been one of the greatest shocks to global growth of the past year, and the conflict has the potential to materially disrupt supply chains in 2019. While the recent truce between Trump and Xi has eased the tensions to some degree, uncertainty remains high. Many supply chain managers know the trade war could ratchet back up at any time.

If new tariffs, or the potential for new tariffs, do begin to disrupt companies' U.S.–China supply chains, what will that mean for other markets? It's difficult to know. These tariffs come at a time when China has more trade to lose, meaning the business position of the United States would strengthen, and consequently so would the U.S. dollar.

Impacts on other Asian countries—and currencies—are likely but unpredictable. However, with the dollar and yuan heavily depending on the trade relationship between the two countries, new tariffs would likely mean that the weakened state of the Chinese yuan will stay, counteracting in small part only the negative impacts of U.S. tariffs.

Other issues.  By their nature, the “unknown unknowns” are impossible to predict. Assassinations and trade disruptions are two examples of areas in which unexpected events are likely to affect global currencies in 2019, but we will undoubtedly experience many other types of events that also have currency impacts. What corporate treasurers can know with certainty is that even the events we can't see coming may gravely impact currencies and companies dealing in foreign exchange.

How to Prepare for Currency Volatility

Foreign exchange volatility is likely to gain momentum this year, as both domestic political and geopolitical tensions continue to mount. Many of 2019's currency swings will be impossible to predict in advance. Still, organizations can approach currency risk strategically, preparing for the unexpected rather than simply reacting once it happens.

In order to be strategic, corporate treasury teams need to understand not only how currencies are impacting their financial statements, but also how they can offset exposures and mitigate potential impacts. Technology tools that include business intelligence, artificial intelligence (AI), and interactive reporting can deliver insights on both counts. Businesses that adopt such “intelligent” technologies are better equipped to develop more sophisticated currency-management processes.

Companies also need to look at their workforce and evaluate which employees have the fundamental skills needed to prepare for and mitigate currency volatility and risks. Data scientists with a solid foundation in finance will be highly sought after this year. They will play a vital role in supporting the finance organization.

Employees without these fundamental skills need to be trained in new ways they can add value. Most companies need to be investing in the continuing education of their finance workforce. Similar to the re-education of large parts of the workforce during the industrial revolution, employees who are executing repetitive processes today should be investing in their future. The material acceleration of robotics, AI, the Internet of Things (IoT), and even biotechnology is changing the world rapidly, in what has been deemed the “fourth industrial revolution” or the “second machine age.” It is imperative that companies and their workforce prepare for this.

These technology and process advancements will enable organizations to better understand how their company may be affected and to prepare themselves for any event that will impact the currency market, be it expected or unexpected.

Wolfgang Koester is the CEO and co-founder of FiREapps. He has more than 30 years of extensive experience in currency markets and working with numerous global Fortune 1000 companies and government entities. Koester is a frequent speaker at industry and academic events, and his work has appeared in The Economist, The Wall Street Journal, Financial Times, Treasury & Risk and AFP Exchange, among other industry publications. He is a regular commentator on CNN, CNBC, Fox Business, and Bloomberg.