Reassessment of Euro Risk

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

The Euro rebound is stronger than anticipated as investors and central banks show an increased appetite for euro denominated paper as signs of a Greek debt crisis start to fade.  The rise in oil prices and surge in central bank reserves has triggered the demand for currency diversification. The euro is one of the few safe currencies that can absorb the growth of reserves.  As we have noted in our blogs of Feb. 26^th and Feb. 15^th, USD or Canadian dollar based investors may want to hedge potential euro exposure.

 

Analysts expect the demand for euro denominated assets to persist temporarily as oil prices remain elevated and central banks, especially in emerging markets, continue to diversify reserves.  This temporary demand for euro denominated may receive temporary support from political tensions in the Middle East and the false sense that problems in the euro peripheral countries have been resolved.  Longer-term, the risks to the euro remain to the downside as the sovereign debt crisis has evolved into a banking crisis and projected economic stagnation in Europe relative to the rest of the world.

 

Spreads on sovereign debt declined since the proposed settlement for Greece was reached.  There is a link between the decline in bond spreads and the ECB announcement the creation of the long-term refinancing operations (LTROs).  There is concern that banks will borrow from the ECB at low rates and buy sovereign bonds whose yields are higher, especially where banks are subject to local political pressure.  Policymakers realize that one of the necessary conditions to stabilize financial markets was the need for an explicit guarantee (such as the ECB) for sovereign debt.    

 

However, this move along with the other temporary financing facilities falls short of what is needed.  Greece and Portugal will not be able to grow with their existing debt burdens.  This could result in contagion spreading to Italy and elsewhere.  European growth is projected to be flat to negative for 2012 and only a modest in 2013, especially with significant budget cuts.

 

The temporary financing could make things more dangerous.  Any wave of sovereign defaults would create problems for the ECB as nearly euro one trillion in sovereign debt is due for rollover in the next 12 months.  The sale of overseas assets by European financial institutions to bolster capital and continued reduction of sovereign exposure by private investors could add to euro pressure.  European politicians have failed to address any of the underlying long-term structural issues facing euro such as monitoring and implementing policies deficit reduction among member states.

Do you take exchange rate views?

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

I recently attended a financial conference.  Near the end was a panel of 3 economists who each gave their views on the economy. Always an interesting session as economists usually give polished, well conceived and authoritative sounding presentations.  The last question they were asked, an old favourite, was what they expected the US dollar / Canadian dollar exchange rate to be in one year’s time.  One economist thought the Loonie (Canadian dollar) would be weaker, one thought it would be stronger and the third thought it would be about the same.  Usually you might expect 6 different answers from 3 economists but in this case, the question only allowed for 3 possibilities and we got them all.  Each economist backed up his forecast with very sound reasoning and was very convincing.

 

In discussing foreign currency risk with potential clients, we are often told that banks have great expertise and provide very good views on currencies and so they follow their bank’s advice and manage their hedging strategies accordingly.  Do you take a view in managing your company’s foreign currency exposures, either your own or that of your bank or trusted advisor? 

 

Two of the economists at the conference work for banks and the third for a highly respected institution.  Each economist at the conference backed up his forecast with very sound reasoning and was very convincing but 2 of them will be wrong and the only correct one will be only correct directionally.

 

As of today, each forecast outcome is possible but only one will happen – to some unknown extent.  It depends on many factors, including a number in process at present as well as “known and unknown unknowns” and psychology. 

 

So in identifying, quantifying and managing your foreign currency risks, the lesson is that you should not include your view as a significant factor in the equation.  We have seen many companies that do this and regret it sooner or later.

Doing nothing is not a strategy; Canadian exporters exempted

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Recently Peter G. Hall, Vice-President and Chief Economist at the Canadian government’s Export Development Corporation stated in his weekly e-newsletter that when it comes to exporters dealing with the “soaring loonie” a survey showed that:

 

“(of the) current coping strategies, the largest group of respondents, at 28%, is simply riding out dollar movements. Cost-cutting is the preferred route for 20% of exporters, while 10% have a hedging strategy. At 7%, a small minority is having success passing on the cost of a higher dollar by increasing selling prices.”

 

So almost 50% of respondents are either effectively doing nothing or hoping that cost cutting in a commodity appreciating world will reduce the risk to their firm of feeling the pain of a strong Canadian dollar.  Cost cutting can work but sadly the costs being cut are probably adversely effecting moral, staff training or future market opportunities; as for “winging it”, that to may limit future growth and profitability. 

 

Why do so few firms go with a hedging (arguably the more sensible route for some) strategy?  The common reason we at RSD have found is a misunderstanding of the strategy or the lack of internal corporate skill sets and the discomfort of senior staff acknowledging this.  Is that where your firm stands?  And is that really a justification for doing nothing or slashing and burning operations to effectively stand still?

Well that was fun,… for some: Canada’s election results

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

May 2^nd was a rather busy day for the global news junkie but here in Canada, international events took a back seat to the Federal election.  What started as a snooze fest was anything but in the last two weeks of campaigning and provided political risk managers – spin doctors (?) with some valuable lessons.  The end result was the Conservative Party received a majority government after three tries, the number three (New Democratic Party) unexpectedly become the number two and the nation’s number two, the Liberals may be going the way of the 1935 British Liberal party.  A special mention should also go out to the Bloc Quebecois which enjoyed one generation of staying power and was wiped out – perhaps joining the Liberal party in the history books.

 

A week after the fact and the dust has settled, a clearer picture of where that leaves Canada’s people and organizations is beginning to emerge.  With a strong left wing opposition, expect the right wing Conservatives to move a little closer to the centre on some issues, but fundamental to the Conservatives is low corporate and personal taxes and continued support for the energy sector (read; oil sands) and possibly agriculture.  Also expect the Conservatives to push for a national securities regulator and be pretty hands-off on the financial and greater business community.  End result: the Canadian dollar will continue to strengthen against the US dollar and likely most OECD currencies.  Expectations for yearend are already $USD 1.09 (CAD .92/1.00 USD) and I can see Patricia Croft’s and David Rosenberg’s three year expectation of $1.20 still a possibility.

 

So the story of the loonie’s rise continues and if anything is now reinforced.  For Canadian exporters, the argument for delaying effective hedge strategies is continuing to get weaker.  The question then is:  what discussions does your risk department have prior to and after an election?  Canada has shown, the unexpected can happen and the results can be significant. 

 

For more on this story click on the link to the Globe and Mail article:

http://tinyurl.com/4xo2jct

 

The Loonie: A new safe haven currency

by Michael Arbow MBA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

 

The past few weeks have been filled with world altering events and uncertainty and the end story for those in Japan, much of the Middle East and the Euro-zone has yet to be written. With uncertainty, the appreciation in the price of gold has happened and is expected but what is not expected is an unwavering Canadian dollar (CAD). In terms of world currencies, when the going gets tough, generally, the tough go the US dollar (USD). However since February 1^st the CAD has traded above par to the USD and that is with long Canadian government interest rates at 80 basis points below comparable US debt and 7 bps below German debt (each holding AAA debt ratings). 

To me this suggests that the CAD is becoming a safe haven currency.  This move is substantiated by double digit immigration and high levels of international capital inflows both of which demonstrate that Canada is globally the preferred place to live and invest.  This new disconnect – that is the Canadian (resource based?) currency as a safe haven, is something to be proud of for Canadians but it will and can cause problems for our exporters. 

Bank of Canada Governor Mark Carney stated last week that the world is in a multi-decade commodity boom.  The effect of this according to economist Patricia Croft and David Rosenberg is that over the next 3-5 years a $1.20 USD/CAD exchange rate could prevail. To me, the trend has become fact.  For Canadian exporters and those investing in the United States, what steps is your organization taking to ease the potential pain?