The rising dollar encourages US companies to hedge exchange rate risks

The dollar has risen about 15% against a basket of currencies over the past year, thanks to an ambitious Federal Reserve and heightened geopolitical tensions that have made the dollar more attractive as a safe haven.

SCHEDULE: Rising dollar

The surge is cutting the profits of US multinationals that convert foreign currency into dollars, heightening corporate concerns about rising inflation and bleak economic prospects and encouraging some to look harder to hedge their profits.

Companies that indicated exchange rate changes in their latest earnings reports include Coca-Cola Co, Procter & Gamble and Philip Morris International Inc., which are 5.6% in the S&P 500 from 6.8% in early April.

“Companies have driven uncontrolled growth of the dollar – and breaking down psychological barriers in most major exchange rates,” said Carl Chamotte, Corpay’s chief commercial strategist.

The dollar is the highest in two decades against the Japanese yen and the highest in five years against the euro, rising 13% and 8% against those currencies this year.

To prevent significant fluctuations in exchange rates that cause significant fluctuations in profits, companies use different types of hedging strategies, including those that use futures and options.

Although there is little industry-wide data to assess the extent to which corporate hedge decisions in the United States are driven by strong dollar growth, several firms that advise currency risk management companies note an increase in hedge activity.

“Some of the companies we work with that have fixed hedging policies have a percentage range of how much of their risk they expect to hedge. We see these clients moving to the top of their range,” said John Doyle, vice president. on trade and commerce Monex USA.

According to Doyle, the hedging activity of Monex customers increased by 22% in March 2022 compared to 2021 and by 24% in the first quarter compared to last year.

The urgency of protection against adverse changes in exchange rates arises after many years of moderate exchange rate volatility, during which exchange rate fluctuations have had a limited impact on corporate profits.

The negative impact of currency fluctuations on the profits of North American companies in the third quarter of 2021 fell to its lowest level since the first quarter of 2018, according to Kyriba’s cash and finance management company in early February.

But exchange rate volatility resumed late last year as investors took a sharp turn from the Fed, which has already raised interest rates by 75 basis points since March. Markets expect rates to rise by 190 basis points in 2022.

The three-month volatility of the euro and yen against the dollar is the highest level since June 2020.

SCHEDULE: Volatility of the euro and the US dollar at the highest level in two years

As volatility increases, “we are already seeing companies adjust their targets to increase profits by 2% or more compared to what they predicted just a quarter ago,” said Bob Stark, Kyriba’s head of global marketing strategy.

Not all recent hedging actions have been aimed at protecting against the growth of the dollar.

Sellers of dollars, including importers, who benefited from the increase in purchasing power from the strengthening of the currency, rushed to record profits, said Chamotte of Corpay.

At the same time, the growth of the dollar has been good for young or smaller businesses, including startups and companies seeking to go public, as they tend to have more external costs than revenue.

Corporate clients of Silicon Valley Bank, which serves young companies, have benefited greatly from the growth of the US currency, said Ivan Asensio, head of currency risk advice at the firm.

“However, regardless of the direction chosen, the prospect of increased volatility has increased hedging activity, awareness and dialogue,” Mr Asensio said.

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