What Is Influencing Corporates’ Currency Hedging Strategies?
Recent research reveals how companies are modifying hedging practices in response to geopolitical uncertainty.
After a period of relative stability in the foreign exchange (FX) market for much of the first half of this year, currency volatility is rising from a very low base level due to a number of factors.
For one thing, more than half of the world’s population is going to the polls in 2024, making this one of the most geopolitically active years we’ve seen in decades. When French President Emmanuel Macron called for a snap election in June, the euro dropped to a two-year low against the pound. As more elections occur in the next few months, including of course the U.S. presidential election, currency volatility is likely to increase over the remainder of the year.
Interest rates are another key factor influencing currencies. Globally, central banks initiated fewer rate cuts than expected in the first quarter of 2024, with the Bank of England (BOE), European Central Bank (ECB), and U.S. Federal Reserve all following the same path of delayed action, creating market uncertainty as participants bet on which will be first to ease.
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Influences on Corporate Hedging Strategies
It’s no surprise that increased political activity and interest rate uncertainty are impacting FX. But what moves are corporate treasury groups making to protect their business? MillTechFX set out to answer that question by surveying 250 senior finance decision-makers at companies in the UK and United States with market capitalization between $50 million and $1 billion. We conducted this research in April 2024. Respondents’ job titles include treasurer, accountant, CFO, financial analyst, and financial manager.
Among these respondents overall, geopolitics proved to be the biggest external factor influencing their businesses’ hedging decisions. Nineteen percent of respondents from the UK chose geopolitics as the external factor most influencing their hedging. However, for U.S. respondents, time and resources (20%) and central bank policy (18%) play a bigger role in hedging strategies than does geopolitics.
Credit availability, selected by 16 percent of all survey respondents, is also having a substantial impact on corporate hedging. And for CFOs across all geographic jurisdictions, central bank policy plays a preeminent role in hedging decision-making.
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How Companies Are Hedging
One of the most important indicators of corporates’ view of FX volatility is how much of their exposure they hedge, also known as the hedge ratio. Generally, the more they hedge, the more protected they are from adverse volatility.
In our survey, the mean hedge ratio of all respondents is 51 percent. UK corporates indicated they are a bit more risk-averse, with an average hedge ratio of 52 percent compared with the U.S. average of 46 percent.
Overall, 42 percent of corporates maintain a hedge ratio between 51 percent and 75 percent, while only 12 percent of corporates have a particularly high hedge ratio—above 76 percent—and only 13 percent have a hedge ratio below 25 percent. This would suggest that most corporate treasury teams are paying attention to their exposures and preparing for continued volatility in the market.
In addition, the average hedge length among survey respondents is 6.8 months. This factor did not differ much between countries; the average UK hedge length is 6.9 months, and the average for the U.S. is 6.5 months. Both numbers represent a sizable increase from last year, when the average hedge length was 4 months in the UK and 5.7 months in the U.S. The data also suggests that the largest businesses (those with more than 500 employees) are the most risk-averse in our current environment, as they are implementing the longest hedge windows (7.5 months, on average).
Within the current state of geopolitics, companies are prioritizing lengthening their hedge windows to secure more certainty and protect their bottom lines from the potential fallout.
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Geopolitical Issues Treasury Should Keep an Eye On
When it comes to the upcoming elections’ effects on hedging decisions, our survey revealed two key trends: Overall, 49 percent of respondents said they plan to increase their hedge lengths, and 39 percent said they plan to decrease hedge ratios, as a direct result of the upcoming elections. These figures were higher for corporates in the UK than for their U.S. counterparts. Fifty-two percent of UK corporates intend to increase hedge lengths, compared with 38 percent in the United States. At the same time, 40 percent of UK corporates plan to decrease their hedge ratios, compared with 32 percent in the U.S.
Organizations which have more than 500 employees again indicated that they are more risk-averse than their smaller counterparts, as these respondents are most likely to be planning to increase both hedge ratios and hedge lengths due to the upcoming elections.
All in all, the impact of geopolitics on currency markets this autumn will come down to how predictable the election results are. If the elections on the horizon turn out to be tight races, or if they deliver surprising results, we will likely see a spike in volatility in the short term.
It’s also important to consider expectations around upcoming fiscal policy changes that would impact interest rates and market expectations. Soon, central bank policy is likely to become the primary driver of currencies, as markets around the world try to determine whether rates have peaked and how aggressively they may be cut over the next year.
From a currency-pair perspective, interest rates will be particularly crucial to watch. For example, if the United States is expected to (and does) deliver more rate cuts than Europe, we may see the value of the euro rise relative to the U.S. dollar. The key metrics driving currency values will be inflation releases and market expectations. Secondary drivers of inflation expectations, such as global purchasing manager (PMI) data, will also garner attention in the months to come.
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