Trendspotting: FX

Part 1: Complacency emerges as a significant risk in Kyriba’s latest “Currency Impact Report.”

Kyriba’s latest “Currency Impact Report” estimates that North American companies experienced $9.32 billion in currency tailwinds late last year. The study is based on an analysis of Q3/2021 earnings calls by 1,200 large multinationals that operate outside the financial services sector. (Note that Kyriba’s next “Currency Impact Report” comes out next month.)

In the current study, one-third of North American companies reported that shifts in the value of the Canadian dollar affected their financials, while just over a quarter identified the euro as impactful. The vast majority of these organizations felt positive effects from the changes to foreign exchange (FX) rates—i.e., “tailwinds.” And among companies experiencing tailwinds, the FX swings improved earnings per share (EPS) by 4 cents on average.

This remarkable finding was a boon to these businesses’ bottom lines. But is that a good thing—and can it last? To answer these questions, Treasury & Risk sat down with Kyriba’s chief evangelist, Wolfgang Koester, who has been a driving force behind the quarterly “Currency Impact Reports” for more than a decade.

Treasury & Risk:  The first thing that jumped out at me from the latest “Currency Impact Report” is that, across both North America and Europe, the proportion of companies reporting tailwinds [12.3%] was much higher than the proportion reporting headwinds [3.1%]. Why were so many companies positively impacted by currency changes in late 2021?

Wolfgang Koester:  Those percentages were a bit surprising to me as well. We need to keep in mind that although the currency impact was positive, it was also non-intentional—and surprises on the financial statements are not good. An unexpected 3 cent-per-share positive impact does not get rewarded at a comparable level to the punishment a company feels with a 3 cent-per-share negative impact.

The risk now is complacency. The Q3/2021 tailwinds occurred in a very quiet, low-volatility environment. In this type of environment, people can react in a couple of ways. They may think currency volatility is gone forever. But I’ve been in this business for more than 30 years, and I can tell you: That’s never going to be the case.

When we see low impacts and low volatility, like we did late last year, then we’re likely to be heading into a time of higher volatility—like we’re seeing right now. But finance teams don’t usually start trying to mitigate those financial risks until they have to report to the board about currency impacts on their earnings and the board says, ‘We need to do something about it.’

T&R:  So, you see a period of low volatility as almost a warning—it’s the calm before the storm, because a storm is inevitably coming?

WK:  One hundred percent. I’ve seen it again and again. Currency trends are very cyclical. You never know where something is going to happen—maybe it will be Brazil or Mexico or Venezuela or China or Russia. But when volatility comes back, it will come back with a vengeance. And it will often happen overnight. I think we’re going to see Q2/2022 numbers materially higher than the Q3/2021 numbers were, for obvious reasons. And once the horse is out of the barn, you can’t reverse that.

For the past six weeks, people have been scrambling to sell rubles. And those transactions are costing a lot of money because the bid-offer spreads are going to be high. Russia has obviously disrupted the global economy, and that is going to have a material impact on corporate financials.

I don’t want to be predictive here, but I think that volatility will remain and the U.S. dollar will continue to strengthen. If Finland or Sweden joins NATO, that is going to make Putin look even worse. High-net-worth individuals in Europe are currently thinking about moving money away from the EU [European Union] and to the United States.

At the same time, corporates are considering where their production facilities will be safe. The Eastern bloc has been attractive in recent years because those countries offer cheap production, but safety concerns may change that calculation. We saw this when the trade war with China ramped up and companies shifted manufacturing to Vietnam or Korea. I expect this time we will see corporates shifting assets from Eastern Europe to the United States. Yes, it’s more expensive here, and we are facing an inflationary environment that is not transient. But manufacturing in the U.S. is safe and predictable.

T&R:  How do you see inflation impacting this trend?

WK:  In the ’80s, Paul Volcker got us out of an inflationary spiral by raising rates. That drove us into a short-term recession, and then he got us out of that recession. The Fed today is emulating that strategy. But the fears today are similar.

People are talking about “stagflation,” and there’s a huge amount of negative news in the world. Companies that have been producing in Eastern Europe are looking at whether they should be doing more in the U.S. And I’m not just talking about companies with operations in Russia and Ukraine; I’m also talking about companies in Turkey, in Poland, etc. Corporate leaders are reassessing where they should be.

See also:

T&R:  What other trends do you see impacting FX volatility in the near future?

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Read Wolfgang’s response in Part 2 of this article.

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