The Kiwi has staged a remarkable comeback in the last month, with the market turning its back on the USD and propelling the NZD back to levels the currency enjoyed at the start of the year. The key market mover has been the US Federal Reserve, who was widely tipped to begin tapering their quantitative easing in mid-September; an expectation that saw the USD strengthen broadly when the idea was first mooted in May this year. When September’s Fed meeting came and went without a firm commitment the market’s disappointment was shown through the USD being dumped – a move that sent the Kiwi surging back to the levels we’re seeing now.
As we look forward to the next three months expect the Fed to remain in the spotlight; September’s meeting didn’t give the market what it wanted, but there are still two more meetings this year (culminating on October 30th and December 18th respectively) and either could see the announcement of tapering. This move would be seen as being USD-positive, though the recent US government deadlock may provide a good enough reason for the decision to be pushed into early next year.
The outlook for the other major’s remains optimistically mixed for the Kiwi; the market focus on the US has seen other areas of the world being relegated to the back page, which has given the NZD some support. Europe continues to struggle, with concerns over the state of the sovereign-debt crippled nations rightly keeping the EUR currency under pressure. The UK appears to be slowly turning the corner, though it will be a long time before the Bank of England has reason to increase interest rates. The Japanese government has committed to keeping the Yen weak in the hope it leads to an economic recovery, so the Kiwi has a chance at gaining further. The Australian dollar has been punished lately – a move that may have been overdone; China appears to be slowly growing (by Chinese standards) and the AUD will draw support from this.
If nothing else, the NZ interest rate outlook should continue to work in our favour, with the RBNZ likely to put our cash rate up sometime next year – a move that sets NZ apart from the other majors and one that will prop up the Kiwi.
As we’ve seen the FX markets have the potential to move rapidly and this can have a significant impact on your bottom line. Protecting yourself from paying more or receiving less when dealing with volatile foreign exchange rates can be a daunting process. However, there are many tools to help you manage this process;
Set Goals. The first step is setting goals – usually the focus is mitigating FX risk, avoiding FX speculation, and locking in FX contracts to protect your business. This will often include setting a budgeted rate.
Identify Exposures. The next step is identifying the best timeframe for your exposures, and the value of the exposure. This might be on a contract by contract basis, invoice by invoice basis, or across all of your stock.
Choose FX Contract Type. FX contracts come in many shapes and sizes, and finding the best fit for your business is important. The most common type of contract available is a Forward Exchange Contract.
- Forward Exchange Contract: This fixes 100% of the contract value, at the contract rate, at the maturity date. It therefore protects you from adverse movements in the currency, but offers no participation in the spot market if the spot rate was to move favourably
- Vanilla Options: These offer 100% protection, but allow for the holder of the option to walk away from the contract at any time. This means if the spot market moves unfavourably – you are safe – you use your contract, if it moves favourably – you can deal on the spot market at better rates. To secure this type of contract, a non-refundable premium is payable up front – usually a small percentage of the contract value.
- Structured Options: These offer the unique combination of protection from unfavourable spot rate movements, participation in favourable spot rate movements, for nil premium. An example of a structured option is a Participating Forward. This offers 100% protection of the contract value at the contract rate, however the holder of the contract is only obligated for 50% of the contract value if the rate moves favourably. This means if the spot market moves unfavourably – you are safe – you use your contract. If it moves favourably – you can deal 50% on the spot market at better rates. There is no premium for this style of contract, however the protection rate is typically lower than what is available on a Forward Exchange Contract.
The key to successful hedging is ensuring you have the ability to secure FX contracts at your budgeted rate or better. Any flexibility you can achieve through the use of options can provide a more suitable balance to your hedging, and help reduce the impact of volatile FX markets.
Execute. It is important to stick to your guns and execute on FX contracts whilst you have the chance. The most common mistake made by businesses, is to “see where the spot rate goes first”. 50% of the time businesses get this wrong, and the opportunity to secure the budgeted rate is lost.
Review. Your policy should be reviewed frequently to ensure you are achieving your goals, and getting the most out of your FX hedging. You may find that the policy is working well, but often tweaks can be made to improve outcomes and keep in touch in a competitive environment.
If you are looking for assistance in managing your FX risk, feel free to call Phil Lynch – Corporate Hedging Manager at Western Union Business Solutions, 09 300 3562.
