Currency Volatility Destroys Companies Profits

Images showing the forex market experiencing currency volatility

Due to globalization, companies whether doing business internationally or nationally are effected by currency volatility which can impact profitability.

For instance, how about losing 298 million pounds in nine months due to emerging market currency volatility. Or Swiss companies facing increasing pressure once the Swiss Central Bank allowed the Swiss Franc to float on the open market.

What is currency volatility?

Currency volatility is a historical measurement determining the fluctuation a currency pair experiences over a period of time. A currency pair is the EUR/USD or the GBP/USD.

For instance the EUR/USD monthly volatility for the past twelve months has been negative 1%.

Example of currency volatility affecting company’s financial position.

Guinness, Smirnoff, Bushmills whisky and Johnnie Walker scotch among other brands combine to create Diageo which is a global alcohol beverage player. Diageo is ranked 264 out of 2,000 companies by Forbes.

Under the current leadership of Ivan Menezes since 2013, he envisioned emerging markets contributing to 50% of total sales. During the past two years it is unclear whether the company has achieved this benchmark. However throughout July 2014 to March 2015, Diageo lost £298 million pounds.

Diageo mismanaged its exposure to reserve currencies affecting the position of emerging market currencies. This loss demonstrates the untold ability of currencies to erode a company’s profits.

Why Diageo was affected?

Typically you may make a Forex payment with a spot contract which is very simple in nature. You have a payment to make, you go to the market through your bank or a currency specialist such as TransferMate and purchase the amount you require.

Using a spot contract a business is open to severe currency fluctuations. Especially when you consider the main currencies such as the US Dollar, Euro and Great British Pound against emerging market currencies such as the Yuan, Brazilian Real or Russian Rouble.

For Diageo it was this relationship between the Great British Pound and emerging market currencies which was why the company lost so much money. Today the Great British Pound trades at 5.76847 Brazilian Real while on the same day in 2014 it was at 3.99835. This is one example which can be replicated across the entire emerging markets currencies.

The turmoil regarding emerging market currencies is severe but the main currencies are not immune to the problems either. The Euro has lost ground to the US Dollar (EUR/USD $1.0865 5/11/15) while on the 5th November 2014 it was at $1.247. This drop is consistent with the 12 month average between EUR/GBP of negative 1.01%. Other currencies have also been affected such as the Australian and New Zealand Dollar, Yuan and Swiss Franc by a strengthening US Dollar.

Other options instead of Spot Contract

While a spot contract is very popular on the currency market making up 45 – 52% of daily volume. Another option is a Flexible Spot contract or Market order.

How a Flexible Spot Contract works

A flexible spot contract is a contract which sets a price today for up to six months. Our currency specialist always suggest no longer than six months because beyond this length of time, the spread is too awkward to predict.

A flexible spot contract provides hindsight as you can budget for how much the contract will cost and at the same time secure your current financial position.

TransferMate enter into the contract with you, agree payment terms on certain dates which are subject to adequate approval of your credit circumstances.

How a market order works?

A market order is an open position on the market which you wish to exchange at. Our team will place the open order on the market, it will only be filled once another person or company meet the open order that our team placed on the forex market.

What the experts expect to happen?

Throughout 2016, markets are expecting monetary policy divergence between the Federal Reserve, Bank of England on one side and the European Central Bank on the other. In October Mario Draghi hinted at extending his quantitative easing programme beyond September 2016 when it was set to expire. This is due to poor inflation across the Eurozone and poor employment growth.

For both the Federal Reserve and Bank of England it is more about waiting for the data to clearly show a strong economy over a consistent period of time. As a result the markets have priced the Federal Reserve to move interest rate by mid-2016 and Bank of England by the end of 2016.

Australia, New Zealand and Canada are between a rock and a hard place as for all three America is a major trading partner. Currently in Australia they are predicting that the central bank will cut interest rates for the third time before 2016, however this is unlikely as the construction and property sector is getting very hot.

Canada is under serious pressure as this year the Loonie has been at its lowest level against the US dollar for ten years. Additionally Canada is experiencing the highest level of capital flight (money leaving an economy) among developed economies. It is not entirely clear what Canada’s central bank will opt to do but it is certain that Canada is in for a bumpy two years against the US Dollar and domestic economic conditions while oil prices remain low.

What Currency Levels to Expect in 12 months:

In level terms, Goldman Sachs believes that the Euro will decline by a further 6 – 10 US cent over the next year. Goldman Sachs based its prediction on monetary policy divergence between the Federal Reserve and European Central Bank.

The GBP/USD will be determined by which central bank moves first and the size of the move by the Bank of England. Currently the GBP/USD has been trading within $1.52 – 1.58 for the past six months. It is likely that during the third quarter of 2016, we would see $1.54 level.

The GBP/EUR once again will be affected by monetary policy divergence as the Bank of England looks to tighten monetary policy while the ECB will have to continue with its quantitative easing programme as it aims to reach inflation of 2%. In level terms, we could expect to see the GBP/EUR reach €1.43.

How to fix this problem

If you are worried that the currency levels stated above could affect you businesses financial position. Contact our team through our landline or alternatively use our live chat. We will be able to guide you through the best approach according to your currency requirements and timing of payments for the year ahead.

TransferMate are currency specialist and make thousands of transactions each week. We are experienced in offering the very best exchange rate with additional benefits such as notifying your beneficiary, same day transfers and an add-on for all the best accountancy packages which save you a bundle of time.

During our time working with clients we have found that they find the time saving a huge advantage and reason why they work with us on a continuous basis.

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