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With the US presidential election set to take place on Tuesday, November 5, wild scenarios in FX and credit markets are being tossed around. As of this writing, the race appears to be too close to call. Bloomberg News calls it a “toss-up election”.

“No opinion pollster,” notes Edward Luce, “can drill into the heads of a few hundred thousand swing state voters who do not yet know their own minds”. Given the uncertainty surrounding this all-important election contest, how are corporate FX risk managers preparing?

In this series of blogs, we look at some of the policy proposals that could spark renewed financial volatility. Given that so much is at stake in terms of FX and credit markets, a few legitimate questions arise:

(a) Should FX risk managers concern themselves with election scenario analysis?

(b) Will concerns about forecasting accuracy gain even more ground?

(c) How should CFOs and treasurers prepare in the face of uncertainty? 

Rising appetite for FX hedging

According to a US Bancorp survey of 1,000 US finance executives, interest in risk mitigation is growing, as 60% of respondents say their appetite for FX hedging has increased while just 15% say it has decreased, compared to 6 months ago.

Bloomberg News also reports rising hedge ratios —from around 50%-60% to 70%-80%— at firms involved in ‘nearshoring’ in Mexico. Corporates "are extending contracts for longer than the usual three-month periods through next year to lock in a peso rate below 20 per dollar".

As Kantox’s Esteban López explains, Mexican corporates with sales in the US are looking to implement layered hedging solutions with two goals in mind:

(1) protecting profit margins from currency fluctuations across not one, but a series of budget periods linked together.

(2) anticipating hedge execution to take advantage of favourable forward points, as USD trades at a one-year 5.87% forward premium to MXN.

Before discussing in more detail how treasurers and FX risk managers should prepare, we need to take a closer look at assessments of tariff policy and monetary policy as proposed by the two candidates. 

Tariffs and uncertainty: the wildcard

Harvard University’s Jason Furman sees the economic agenda of Democratic candidate Kamala Harris as “less of the same” when compared to the current policy setup. This is because: (a) she would face stiffer opposition in the US Senate than is currently the case; (b) a Covid-induced type of economic stimulus would not make any sense now.

Ms Harris is also on record for pledging to respect the independence of the US central bank, the Federal Reserve. All of this stands in sharp contrast to the Republican party’s candidate. This is why all eyes are on Donald Trump’s economic program and his plans to raise import tariffs. 

The Republican party candidate proposes increased tariffs, including a 20% across the board tariff on all trading partners as well as 60% or higher tariffs on goods from China. There is talk of a 100% tariff if the dollar is not used—and even of 200% tariffs on some specific companies.

“Tariff,” says Mr Trump, “is the most beautiful word in the dictionary.” His striking proposals reflect the enormous latitude that US presidents have in terms of trade policy.

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Possible impact 

The proposed across-the-board 20% tariff to the rest of the world would likely raise both the cost of consumer goods that are not produced in the US, and that of intermediate inputs to manufacturing. This policy prescription could shrink both imports and exports. 

Would increased tariffs provide solace in terms of the US budget deficit? Scrapping the federal income tax and replacing it with revenues from tariffs on imports is one of the most attention-grabbing proposals on display. Mr Trump has also called for extending the tax cuts enacted in 2017.

Analysts at the Peterson Institute for International Economics estimate that revenue-maximising tariffs on imports can deliver only 40% of the revenue from the income tax to be replaced. Needless to say, this would be bad news in terms of the US fiscal balance.

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Trade Policy Uncertainty: would tariffs solve trade imbalances?

Assuming that tariffs are raised to sky-high levels, would this reduce America’s trade imbalance? Some commentators respond in the affirmative. Others are more sceptical. A study published by Deutsche Bundesbank analyses the impact of the Trade Policy Uncertainty (TPU) that would likely be unleashed.

Trade Policy Uncertainty is an empirical indicator based on news indices that compute the fraction of newspaper articles on trade policy that contain related keywords. There is robust empirical evidence that TPU dampens trade.

As it turns out, Chinese exporters typically respond to US-imposed tariffs —and the resulting TPU— by lowering USD prices to maintain their competitive position. They do so by about 0.75%, on average, in response to a 1% USD appreciation. And that's how tariffs may backfire as an attempt to correct trade imbalances.

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Corporate treasurers and geopolitics

A more aggressive tariff policy from the US could be viewed as a form of economic sabre-rattling. This could then escalate into a full-blown trade war with unpredictable consequences. Recent surveys show the degree to which CFOs and treasurers worry about geopolitical risk, especially in regard to the US and China. 

The US Bancorp survey cited above shows that 32% of respondents flag geopolitical tension and war as a top-three risk, up from 26% six months ago and 17% in 2023. Finance leaders say it is now the third most important business risk. Just 12 months ago it was the least important.

Over at HSBC, economist Shanella Rajanayagam argues that, on the trade front, “geopolitical tensions are seen as the key downside risk. We have been flagging this since the beginning of this year, not only the risk that such tensions persist, but that they could escalate.” 

The recently published HSBC 2024 Corporate Risk Management Survey finds that 47% of respondents see FX risk management as an area they feel their business is least well equipped — a vulnerability that is partly due to exchange rates moving significantly in reaction to unexpected geopolitical events.

In our next blog, we will take a closer look at what Kamala Harris and Donald Trump have to say about the dollar and interest rates, before closing this series with a roadmap for treasurers and FX risk managers.

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The previous blogs of this series clarified some of the most important points treasury teams need to consider when they implement a layered FX hedging program. These elements include:

• Pricing. Layered hedging is best suited for companies that need continuity on pricing, i.e., keeping prices as steady as possible 

• Misconceptions. While treasury teams might face constraints, there is more to layered hedging than just ‘rolling’ the hedges

• Commonality. Best practices in layered hedging are centred around the notion of commonality between average hedge rates

In this final blog, we present the automation requirements of a well-run layered FX hedging designed to systematically achieve a ‘smooth hedge rate’ over time. This is the only way management can keep steady prices over many periods—without hurting budgeted profit margins in the face of adverse developments in currency markets. 

Layered FX hedging: the automation imperative

Picture yourself as the treasurer of streaming giant Netflix. You have more than 40 currencies to manage—and unhedged exposures can make or break the firm’s financial performance, as 60% of total revenue comes from foreign sales.

In one of the pricing segments, the finance team has just been given a seemingly impossible task. Whatever happens in currency markets, the team needs to protect the firm’s profit margins while allowing management to keep steady prices—not just during one budget period, but as long as possible.

This mission involves a good dozen FX-layered hedging programs. To achieve commonality between hedge rates in each of these programs, a precise schedule of hedges must be established and executed. The more granular the program, the more effective it will be. 

Different value dates will reflect different degrees of forecast accuracy. Also, each currency pair will display a different scenario in terms of forward points. For example, USD trades at a 5.5% forward premium to BRL, but at a 3.8% forward discount to CHF. Series sold in Brazil will have to be hedged differently than the EUR forecasted revenue. 

This means that the treasury team needs to calibrate each program to optimise forward points, taking advantage of favourable setups, while delaying hedge execution when facing unfavourable forward points. This, in turn, requires treasurers to adjust the length of the program and/or to set conditional orders to delay hedge execution. 

And it’s not over. When combining a layered FX hedging program with a micro-hedging program for firm commitments —by far the most effective way to achieve the goals of the program—, two additional elements require API-enabled automation:

• ‍24/7 markets monitoring‍
• ‍End-to-end traceability

24/7 markets monitoring

As we saw in the previous blog, the combination of a layered hedging program and a micro-hedging program for firm sales/purchase allows treasurers to work around constraints they might face regarding their degree of forecast accuracy:  

• ‍Initial hedging is based on forecasts. As firm orders take some time to accumulate, hedging is at first carried out according to the layering schedule chosen by the treasury team. ‍
• Accumulated firm orders take over. As soon as accumulated orders surpass pre-determined hedge ratios, hedging is automatically done on the back of firm commitments.

Achieving this combination is easier said than done. On the one hand, the budgeted part of the exposure is based on forecasts that often sit on Excel spreadsheets. On the other hand, firm sales orders may originate from the company’s CRM or other system.

This involves at least two different sources of exposure information, with different ‘owners’ within the firm. With system-agnostic API connectivity, treasurers can ‘feed’ their layered hedging program with all the exposure data they require. 

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To visualise this complexity at work, consider the chart above. The orange area shows hedged positions of a given value date. As the corresponding sales or purchase orders are received, their accumulated amount is initially below the hedge ratio set by the layered program.

To avoid over-hedging, these positions are not hedged. However, as soon as their level surpasses the indicated hedge ratio, the program is automatically ‘switched’, executing hedges only based on firm exposures.

Note that the illustration displays only one value date and one currency pair. The treasury team need only to multiply this setup by all required value dates, and then by all currency pairs, to realise the impossibility of manual execution.

Traceability: automation requirements

Further automation is required to track the hedged sales/purchase orders to the corresponding forecasted exposure. This makes it possible for finance teams to apply Hedge Accounting under IFRS 9 and US GAAP. 

Hedge Accounting can be a time-consuming task that, when manually executed, requires skills in accounting and the valuation of financial assets. Companies sometimes shy away from applying Hedge Accounting —and even from currency hedging altogether— due to the perceived costs in terms of documentation and compliance.

API-enabled traceability allows finance teams to easily perform all the work involved in compiling the required documentation. The same can be said for the task of using FX swaps to adjust the firm’s hedging position to the settlement of its underlying commercial exposure. 

Given the role of traceability in accounting and swap execution, it comes as no surprise that a recent EACT Treasury Survey reveals treasurers’ preference —when it comes to treasury technology— for Data Analytics and APIs.

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Layered hedging meets technology

The practice of achieving a ‘smooth’ hedge rate over time is being redefined as we speak. It is no longer enough for treasury teams to take a more or less random series of hedges and set arbitrary hedge ratios in the hope that their forecast accuracy will save the day.

We can go one step further, as we saw in the previous blog. Technology makes it possible for finance teams to fine tune their layered hedging program to take advantage of favourable moves in exchange rates: 

• Maturity flexibility. If the spot FX rate moves in a favourable direction, the finance team can increase the length of the layered hedging program.

• Hedge ratio flexibility. If the spot FX rate is more favourable in the current period than in the previous period, the hedge ratio can be increased for nearer-term exposures. 

This is accomplished by applying different ‘partitions’ to the hedging program, allowing the software solution to monitor FX Markets 24/7 to automatically increase hedge duration or hedge ratios whenever currency markets move in a favourable direction.

Thanks to Currency Management Automation solutions, the inherent complexity of such programs is no longer the daunting challenge it used to be. By allowing firms to protect their competitive position while reducing cash flow variability, treasurers make it possible for business managers to confidently use more currencies in their operations