FX volatility continues amidst a tepid economic recovery
- September 14, 2020
Client Relationship Management
Corporates | Kennett Square, PA
As summer ended, we saw several market and economic headlines that treasury teams should carefully monitor as their organizations plan for 2021. The euro and British pound continued to experience heightened volatility, while the VIX spiked and crude oil broke down following a pretty placid summer.
A tale of two currencies
During a European Central Bank press conference on Thursday, President Christine Lagarde struck a positive tone as she contemplated a stronger-than-expected economic recovery for the Eurozone. Her optimistic remarks and decision to leave the bank’s key interest rate unchanged caused the euro to further rally after cooling off earlier in the week. Addressing concerns related to euro strength and the impact it could have on a fragile economic recovery, Lagarde commented that the ECB is monitoring the currency’s movements, but they do not target a specific FX rate or range.
Currency movements across the English Channel drew a sharp contrast to the recent Euro strength, as the British pound continued to slide. The U.K. government unveiled a Brexit bill that would override elements of its original withdrawal agreement with the European Union, making it increasingly likely that there will be no trade agreement in place before the October 15 deadline. The prospects of higher trading costs and tariffs between the two parties put more downward pressure on the pound, which ended the week at 1.28.
(Related insight: Download Chatham’s Benchmark Study Report, "The State of Financial Risk Management," to see what peer corporations are doing to manage FX risk.)
COVID stimulus talks wear on as U.S. markets turn choppy
Equity market volatility continued against a backdrop of risk-off investor sentiment following the pre-Labor Day decline in tech stocks. Despite the growing consensus that the recent correction is a healthy market adjustment that brings prices closer to underlying value, equities failed to gain any significant momentum in either direction for the week. COVID stimulus talks did nothing to help boost investor or economic sentiment, as both sides of the aisle drifted even further apart in their respective visions for a relief package. Republicans floated increasingly smaller relief plans, culminating in the proposal of a $300 billion bill on Thursday, on which Senate Democrats blocked a vote. 10-year treasury rates slid 3 basis points on the news, reversing an earlier increase driven by unemployment claims holding steady week-over-week.
Rangebound crude breaks lower
After drifting higher for most of the summer, crude oil markets saw a sharp correction lower on account of compounding negative headlines. Earlier in the week, Saudi Arabia announced it would be cutting prices for October shipments to Asian and U.S. refining customers due to continued weak demand. This was followed by the U.S. Energy Information Administration reporting a 2-million-barrel increase in crude oil inventories, catching a market expecting an inventory decrease even more off-guard. While we transition away from summer and peak seasonal demand, there are mounting downward pressures for OPEC+ to wrestle with when they meet next week.
(Related insight: Read "Market volatility impacts fuel markets.")
In addition to monitoring crude oil volatility, we can expect to see markets respond to a Federal Reserve Chair press conference scheduled for Wednesday, September 16, which will be Chairman Powell’s first public address since the August announcement of their change in approach to managing inflation.
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Our featured insights
The Federal Open Market Committee (FOMC) met on Wednesday, September 16, 2020. Chairman Powell emphasized the Committee’s focus on achieving an inflation rate that averages 2 percent over a longer time horizon.
Equity markets saw continued growth early in the week, with the Nasdaq and S&P 500 reaching all-time highs on September 2. However, Thursday saw a massive sell-off led by the tech industry, signaling that investors are growing wary of record stock valuations against weak macroeconomic fundamentals.
Following the steep drop in USD interest rates, many swaps became significant liabilities. Companies can consider an extend-and-blend strategy, which reduces their swap rate to lower cash interest expense and extends hedge coverage by several years.
As we close out summer and brace for cooler weather, the Federal Reserve opened a new chapter on Thursday in its approach to monetary policy. They will shy away from the famed Goldilocks approach to managing inflation and articulated a new way of responding to economic challenges facing our economy.
Volatility is expected as the market reacts to initial jobless claims, consumer confidence numbers, and the Republican National Convention. While existing home sales beat expectations, jobless claims once again exceeded one million and the Fed pushed back the timing of its forward guidance targets.
A week that began with confidence that Congress would pass another round of fiscal stimulus provided a catalyst for investors to move from safe havens, like bonds and precious metals, into equities.
While the employment data showed optimism, Treasury yields reflect limited expectations of economic growth and inflation. In this low rate environment, corporates continue to employ extend-and-blend structures for previously hedged floating rate debt and forward hedging of future fixed rate debt.
Ensuring an effective, compliant hedging program means assessing both visible and hidden costs across all hedging activities, including strategy and pricing, legal and regulatory, and accounting.