Aside from Martin Shkreli and Star Wars, our watercooler chat was centered on the Fed’s decision to raise
key interest rates for the first time since 2006 to a range of ¼ to ½%, up from the previous 0 to ¼%. The decision to increase rates came as no surprise, as Fed Chair Janet Yellen had alluded to the desire to raise rates for some time in order align rates with that of a healthy economy, and more importantly, give the Fed some room to maneuver in case of another recession. It is suggested that at least 3% is needed in order to give the Fed the ammunition to combat another recession, but the Fed has already told us that they expect to raise rates in a very passive and predictable way so it shouldn’t generate a huge amount of volatility or uncertainty among financial markets.
The Greenback appreciated against the Canadian Loonie, British
Pound, Japanese Yen, Australian Dollar and Euro
Another conversation gaining more attention is that of the dropping
price of crude. Due to this fact, the second biggest loser after the
Pound last week was the Loonie. Relying heavily on the price of oil to
maintain its value, the Canadian Dollar declined as its largest export devalued by over 7% last week. Western Canada Select was already well below $30/barrel.
The reasons for the change in the cost of crude are twofold – weak demand in many countries due to insipid economic growth, and second, surging U.S. production. United States domestic production has nearly doubled over the last six years, pushing out oil imports that need to find another home. Saudi, Nigerian and Algerian oil that once was sold in the U.S. is suddenly competing for Asian markets, and producers are forced to drop prices. Canadian and Iraqi oil production and exports are rising year after year and even the Russians, with all their economic problems, manage to keep pumping.
Goldman Sachs sees further weakness for oil due to the worsening of already weak fundamentals after oil cartel, OPEC, held back from cutting production at its recent meeting. The group of 13 oil-producing countries has kept its production ceiling around 30 million barrels a day for years, with kingpin Saudi Arabia standing firm against an output cut in order to maintain market share and drive higher cost producers out.
In addition to this, in a move considered unthinkable a few months ago, Congress agreed on Friday to lift the US’s 40-year ban on oil exports. This is an historic action that reflects political and economic shifts driven by the boom in U.S. oil drilling. U.S. oil producers will now be able to sell crude to the already saturated international market further driving down the cost.
There was positive news out of New Zealand, as the GDP Price Index posted a gain of 1.9%, a second straight gain for the key indicator, breaking a nasty streak of three consecutive declines. Positive GDP and Business Confidence also supported the currency’s 0.42% gain last week, but that’s hardly what anyone is talking about today.
The U.K. Pound was the big bear of the week having been previously immune to USD strength. Deutsche Bank has now revised their forecasts for 2016-17 suggesting we’ll see levels as low as 1.35-1.40 for the GBP/USD pair. In response to the FED rate hike the Bank of England is expected to raise rates in the New Year and all eyes will be on their next meeting on Jan 14th to see if they increase rates, but also if their statement is as dovish as the Feds.
Lastly, even with its most recent gains, Deutsche Bank and ABN Amro remain extremely bearish on the euro both predicting parity with the US Dollar in 2016 while others, including HSBC, are a little more optimistic predicting a high of 1.20 in Q4 2016. Although French, German and Eurozone manufacturing PMIs all beat expectation last week, when it comes to the euro in 2016, all eyes are on the Fed and a potential slowdown in China as possible indicators of future euro performance.
Three Currency Predictions for 2016
In the past few weeks, we’ve focused on the ever-growing influence of the Chinese Yuan in global financial markets. This has led us into our last Dispatch of the year, and some predictions for 2016. These predictions are not ours, but are reliably put together by the well-respected, Wolfgang Koester of FiREapps.
The biggest currency story in 2016 will be the Chinese yuan becoming more closely tied to world currencies other than the U.S. dollar, and the very significant business risk that represents for multinational companies. But there will be other significant stories as well.
We are now in an environment where CFO’s can no longer manage currency and the associated business risks by a version of the old “80/20 rule” (in this context, having a good [80%] understanding of the currencies impacting a financial statement). CFO’s are awakening to the fact that the less-understood 20% may present very material risks.
Given that environment, corporate boards, CFO’s, and CEO’s will be seeking greater insight into how currency could impact business operations. In 2016, more than ever, corporate executives will need to know “what it means for [this element of our business] if [this currency rises/falls].”
Here are three currency predictions for 2016:
1. Volatility will no longer be a “new normal,” but rather just “normal.” Currency-driven business risks are a fact of life for multinational companies. In this year’s third quarter, for the fourth quarter in a row, negative currency impacts to corporate earnings were magnitudes above previous years’ averages, according to an analysis by FiREapps. Contrast this sustained volatility with 2012’s euro-driven currency crisis, which lasted two quarters and caused more than $40 billion of negative impacts to U.S. corporate earnings, according to research by FiREapps. It’s a different world now, and all indications point to this trend continuing into 2016.
In 2016 hot spots might include the eurozone, Russia, Japan, and Latin America.
The eurozone: Since mid-2014, U.S. multinationals have cited the euro as an impactful currency as often as they’ve cited all other currencies combined. The euro hit historic lows in 2015 as concerns about the eurozone economies persisted, new geopolitical risks arose, and the monetary policies of the eurozone and the United States continued to diverge (the European Central Bank continued its pursuit of quantitative easing, and the U.S. Federal Reserve tightened policy with an interest rate hike). Expect uncertainty, volatility, and a weaker euro to continue.
Russia: The ruble was incredibly volatile in 2015, rising 42% from a late-January low to a late-May high, then falling 25% by late August. Early in the year, we saw multinationals like General Motors go so far as to temporarily suspend operations in Russia, citing accelerated volatility. In 2016, Russia will continue to be a big question mark.
Japan: Though not nearly as much as the ruble, the yen exchange rate was also marked by volatility in 2015. The yen isn’t in position to strengthen next year; the Japanese economy fell back into recession, and most analysts predict the Bank of Japan will respond as it has been responding: with more monetary stimulus that subsequently drives down the value of the yen. A weak yen has significantly weakened corporate revenue, and multinationals should prepare for more of that in 2016.
Relative to those currencies and others, the U.S. dollar is likely to continue to strengthen in 2016. Given the economic and geopolitical turmoil elsewhere in the world, the U.S. dollar will continue to be a safe haven and sustain an environment in which companies have to operate under a mandate to innovate and focus on quality, rather than produce the cheapest export/product possible. For U.S. multinationals, this means more business risk.
2. China will further loosen its grip on the yuan. Many multinationals are highly exposed to China’s yuan (the basic unit of the renminbi, or RMB, the country’s official currency, in much the same way that the British pound is the basic unit of pound sterling). But many haven’t been actively managing the currency and its associated risks. That was because of its close peg to the U.S. dollar, which meant there was little exchange-rate volatility for companies to worry about.
That changed on Aug. 11 of this year, when China surprised markets by allowing the yuan to fall by nearly 2% against the dollar. The decline continued in the following days, hitting a four-year low against the dollar. This led to volatility for many Asia-Pacific currencies as countries took action aimed at maintaining parity against the yuan. This tracks with what we’ve seen as the euro has weakened against the dollar. Volatility in a major currency creates a ripple effect around the world.
China is poised to further widen the yuan trading band in 2016, in large part because the RMB will become the fifth currency in the International Monetary Fund’s “basket of reserve currencies,” known as Special Drawing Rights (SDR) currencies. As China moves to a freely floating trading band (an expectation of the SDR currencies), the yuan will likely experience unprecedented volatility. In fact, the volatility we’ve seen in 2015 — and the associated business risk to corporates — will pale in comparison. In 2016, for the first time, the yuan will be a risk that many multinationals will actively manage. While Morgan Stanley is calling 2016 “Yen Year,” We think “Yuan Year” will turn out to be a much more apt characterization.
3. Boards, CFO’s, and CEO’s will look to FP&A for insights Corporate financial planning and analysis (FP&A) teams will need to be prepared to answer tougher questions about how currency volatility will impact business operations. The questions will require granular, often time-sensitive currency data. Such questions may include:
What does it mean for the supply chain if the Brazilian real has another big first-quarter fall?
What does it mean for expenses if China widens the yuan trading band by another 2%?
What does the hike in U.S. interest rates mean for net income?
What does it mean for the cost of goods sold in Japan if Japan resumes active devaluation of the yen?
What does it mean for revenue if the euro falls to parity with USD?
Many CFO’s have been asking these questions for the last six months. Until this point, FP&A had not had to be particularly involved with currencies, nor had they been asked to take a specific look at them, at least not to the level that they have to now. These kinds of questions are getting vastly more complex, and they surely will be harder to answer in 2016.
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