Managing Currency Risk Webinar: 2013 Volatility, Economics, Technology & Regulations
In 2012, U.S.-based multinational corporations saw negative currency-related impacts to their financial statements well into the double-digit billions ($22.7 billion in the third quarter alone). 2013 promises to bring more of the same as increasing volatility in global currency markets continues. Discover the three top sources of currency volatility to watch out for in the coming year as identified from in-depth research into hundreds of 2012 analyst calls.
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Gain actionable insights into the macroeconomic trends that are driving volatility and receive an update on the changing regulatory landscape that is reshaping derivative accounting for US-based multinationals.
This video is from the Proformative webinar "Managing Currency Risk in 2013: Volatility, Economics, Technology & Regulations" held on January 23, 2013. The webinar features presentations from Karl Schamotta, Senior Market Strategist,
Managing Currency Risk Webinar
Partial: "I'm very happy to join everyone in here as well, and thank you very much for that kind introduction. Also thank you to Firehouse and Performative for the opportunity to join today. I think this is going to be a great discussion. I really love the timing of this event. Today, the planet's most influential leaders are meeting in Little Swiss Ski Resort to discuss the fate of the world.
As they do so, they will issue a series of forecasts and opinions that we're all intended to take very, very seriously. We're going to see those forecasts reported in the media for the next couple of weeks. The reality is that most of them will be wrong.
In 2011, the French Finance Minister said that the
Now, today, if you listen to the speeches being made, many of the same people foresee calm sailing ahead for the global economy. The financial markets are mirroring this perception. They're extraordinarily calm, with most participants feeling optimistic about the global economy's prospects in the year ahead. Volatility expectations are at historical lows.
As Yogi Berra put it, "The future just ain't what it used it be," and it really never is. It's unlikely that current expectations accurately reflect the future. Now, to be clear, I don't think that the global economy is about to fall into crisis. The future really does look brighter than it has in many years, but currency movements are all about relative changes, not
Some of the most dangerous episodes of currency market volatility are triggered in times just like these, when the global economy is undergoing a number of positive structural adjustments, and market participants haven't yet priced those adjustments in.
I'd like to kick off today's session with an overview of the factors that are likely to cause havoc in the months ahead. The idea here isn't to tell you what exchange rates will look like in the future, but to briefly outline the areas where current prices are vulnerable to realignment. Before I do so, it's important to look at how we got here, really as
Wolfgang was pointing out.
As illustrated here, in the aftermath of the financial crisis, an incredibly simplistic global consensus emerged. With the developed world trapped in recessionary conditions and the emerging countries recovering extremely quickly, the strategy was obvious. You borrow in the developed countries and invest in the emerging countries, or invest in the raw materials that those emerging countries would need.
The dollar and the euro plunged for two years after the crisis, while commodity-linked and emerging market currencies soured. This really touched off a lot of the volatility that we saw. Now, of course, whenever you've borrowed a lot of money in one currency and lent a lot in another, you're always going to be worried about a convergence between the two.
If your borrowing position rises in value while you're lending and one falls, you're going to lose a massive amount of money. We began to see what is often called the risk-on, risk-off trade. When traders were optimistic, they borrowed in dollar or euro and bought risky assets. When they weren't, they sold these off as quickly as possible and repaid their loans.
Given the size and risk associated with this trade, when growth rates and current accounts actually did begin to converge in 2011, we saw a complete chaos in the currency world. The consensus collapsed. As you can see, commodity-linked and emerging market currencies underperformed. The dollar surged back as traders repaid the dollar denominated borrowings, and then the euro began to do the same in the latter half of 2012.
With no clear stories to trade on, speculators moved to the sidelines. Volumes and volatility plunged, and as we entered 2013, this really remains the case. Currencies are tightly range-bound and speculative positioning remains extremely low. The euro provides an excellent example of this. Sentiment has improved markedly.
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Since the ECB president's commitment to do what it takes to resolve the liquidity crunch back in August, the number of people searching for information on the euro crisis has fallen dramatically, mirroring the developments we've seen in the financial markets. Short positions are a fraction of the size they once were. So are the problems in Europe over? In a word, no. Sorry to deliver the sad news there.
The European economy continues to worsen, and I think you've all seen the forecasts that call for subzero growth in the coming year, so I'll focus on something else entirely. This slide illustrates the divergence that we're seeing between unemployment rates in the core and peripheral countries. Average jobless rates in the periphery have gone past the 19% mark, while core countries perform near their long-term historical averages.
Europeans are feeling the pain, and even worse, it's not evenly distributed across the common currency area. Now, why is this important? Because history tells us that these are perfect conditions for political upheaval. I think this drives it home. We've seen support for the EMU for the common currency erode dramatically over the past year. People across Europe are turning against the common currency project.
This means that these disenfranchised constituencies are ripe for the picking from a political perspective. Now to be clear here, I'm not saying that the currency will collapse, or even the countries will leave in the short-term. In a financial sense, the common currency area is looking more stable by the day. Spreads are narrowing, target two unbalanced are unwinding right now, and ECB liquidity is alleviating funding risk.
Traders are repaying their Euro loans and the currency is rising, but I do expect that (inaudible 00:07:43) will begin supporting parties and leaders on the extreme edges of the political spectrum. As they do so, we are likely to see instability and volatility episodes in the financial markets, particularly around the regional elections that are scheduled for the coming months. Treasurers really cannot begin ignoring Europe just yet. The key is to watch the political arena, to plan for some degree of upheaval,
and to remain protected in the event of an extreme slide in the markets or a sudden slide.
Turning to the United States, this chart shows the evolution in the CBOT's VIX Index, otherwise known as the "fear index" over the last few years. As you can see, we're now trading at incredibly low levels. This is despite the fact that we saw volatility spike when we got down to the wire on December 28.
As debt ceiling negotiations progress, I would expect that we will see at least one more short-term spike outside of current ranges. If and when it does come, treasurers need to be prepared to capitalize on some very short-term trading opportunities. Beyond the political negotiations, I would strongly suggest, though, that the United States is in far better shape than many believe. This is likely to cause an entirely different kind of upheaval.
This chart illustrates the total commercial bank loan portfolio in the United States since the financial crisis. Over the past few years, I've been repeatedly saying that the Fed's stimulus efforts were having little effect because the transmission channel wasn't working. Loans were falling, meaning that the average business didn't really see any of this easy money that everyone was talking about.
Sometime in late 2011, this began to change in a sustained manner. Loans began to rise and to rise steadily. Money began to flow into the economy, setting the stage for outperformance. This year, I think we'll see more of this improvement throughout the real economy as the circulatory system starts to work again.
That being said, an improvement in the United States really isn't a recipe for smooth sailing in the markets at all. Quite often it's the exact opposite. After years spent front-running the Fed's stimulus actions by driving yields down, traders are now running in the opposite direction driving them up as they anticipate an eventual end to easy money, and as they rotate into growth assets.
The bond bubble is going through a quiet collapse, and this is causing differentials between the dollar and other majors to change."
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