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Currency Risks: Disturbance in the Water

After two years of relative stability, the currency markets may be readying for a year of heightened volatility. Will companies be prepared?

At the same time, while the euro zone is technically exiting its recession, with gross domestic product in the third quarter up 0.1%, it’s still digging out of its financial and fiscal crises, and a strong euro is not helping.

In Japan, the government has adopted significant monetary and fiscal expansionary policies — even more aggressive than those of the Federal Reserve — “in an attempt to revive an economy that’s been in a generational malaise,” Frey says. “They are throwing every tool in the tool kit at the economy, and if doesn’t work there is nothing left to fall back on.” Add in some emerging economies actively managing their currency prices by stepping into the forex markets to stem selling pressures, and the currency markets “are entering a period where there are a lot of unknowns.”

When there’s a prolonged period of relative quiet, “a socioeconomic or political event can create a pretty exaggerated reaction in the market, whereas if there is a prolonged period of momentous events the market tends not to react in a knee-jerk fashion,” says Schulz.

Adds Frey, “We saw the violent reaction [last September], when the market believed the Fed was going to begin tapering QE. The market reaction was swift and sudden because we were all surprised.”

Not All About Volatility
What if developed-economy currencies are relatively stable in 2014? “Microfluctuations can be just as harmful to a company,” says Schulz. A study released in October by Fireapps, a vendor of software that helps companies manage forex exposure, said currency-related losses by U.S. companies totaled $7.7 billion in the relatively stable first half of 2013.

13Dec_Outlook_p28aIf a U.S. company agreed to pay a European supplier $1 million euro for a parts order last July 14 and didn’t hedge against a euro-dollar currency move, it experienced pain 90 days later when it had to pay. On Oct. 13, in U.S. dollar terms, those parts would have cost the company 6% more than when it signed the contract.

While a small, single-currency movement may not have a huge impact, when a company is exposed to multiple currencies, all of them can move unfavorably at once. In its October earnings report, French manufacturer Michelin, which is trying to expand outside Europe’s ailing economy, said its growth was stunted by currency swings in the United States, Japan and South America. Marc Henry, a group CFO for the company, said he expected exchange-rate fluctuations to “burden” full-year operating profit by about 250 million euros, a 100 million-euro increase from the impact Michelin forecast in the previous quarter.

Other companies are preparing for greater volatility. While the euro may have traded in a tighter range versus the U.S. dollar for some of 2013, some U.S. companies view European currencies as increasingly volatile. During its October earnings call, data-center services provider Equinix said that “given the volatility of the European currencies” it initiated a cash-flow hedging program to limit its future exposure to fluctuations in the British pound, the euro and the Swiss franc. By doing so, said CFO Keith Taylor, the company expects to reduce forex volatility on 40% of its revenues and adjusted EBITDA from its Europe, Middle East and Africa business. Revenues from that business are growing close to 20% a year.

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