J.P. Morgan’s View: Why rising volatility could blow out your existing FX strategy
Q1: What’s happening in the currency markets?
After spending much of 2017 at multi-year lows, the J.P. Morgan FX volatility index – which tracks the level of implied volatility in G7 and emerging market economies – rebounded to nine-month highs earlier this year.
There are several drivers behind the market swings. In the short term, currency markets will remain sensitive to major economic factors including global trade policies, global growth momentum and the pace of rising US interest rates.
In March 2018, the world watched as US-China trade tensions escalated. US imposed tariffs on various Chinese goods were met with a swift response from Beijing. Early in May, both countries met for a two-day trade discussion that Chinese media reported as having been “frank, efficient and constructive”. While our base case assumes continued negotiations between both parties we acknowledge that trade tensions are on course to escalate. As a result, the currency markets may have to contend with a protracted period of uncertainty.
At risk is the potential impact to the global growth momentum, which has been supported by a rebound in trade in recent years. While we don’t expect the announced tariffs to have significant impact on GDP, a bigger concern is the threat of non-tariffs action should the US decide to impose measures on China to open up its market or restrict Chinese investment in the United States in order to protect intellectual property. The frictions along this front could affect a broader range of sectors and have a long-lasting impact on the world economy.
The FX markets are also keeping a keen eye on US interest rates. The Federal Reserve in March raised rates by a quarter of a percentage point – its sixth rate hike since the financial crisis – and kept its hawkish stance as it looked to return to more normal monetary policy. Rising US interest rates are viewed to be positive for the US dollar; J.P. Morgan’s house view is for another three rate hikes this year.
Head of APAC Core
Services, J.P. Morgan
Q2: What are the key challenges treasurers face in managing FX?
As corporations grow and expand globally, treasurers managing FX find it challenging to identify, understand and measure the types of exposures within the business. Achieving full visibility of FX exposures can be a manual, resource-intensive activity, with varying degrees of FX forecast reliability. This introduces a lack of flexibility as market conditions evolve.
Having a complex bank account structure also exposes the company, particularly if it involves numerous accounts in non-functional currencies spread across different banks. Often this structure is a result of an amalgamation of bank accounts that have sprung up from years of business growth, acquisitions or special projects, and they typically operate across different technology platforms. Without an integrated platform, moving liquidity across the firm to manage FX risk can be an onerous exercise, especially amid fast-changing market conditions.
Understanding the relationships between hedging activities and the flow of business that created the exposures in the first place can also be challenging and without a cohesive view this can create missed opportunities to aggregate currency exposures.
Q3: Can you share some best practices in coping with FX volatility?
The best ways to cope with FX volatility can be managed through two steps: simplifying bank account structures and freeing up liquidity.
Simplifying bank account structure
Treasurers should look to adopting account structures that match your business flows and reduce the number of accounts, keeping only the essential ones open and shutting down the rest. For example, if a Singapore corporate whose functional currency is US dollar has an Australian dollar (AUD) account in Australia processing very small volumes of AUD payments, it may make sense to close the AUD account and make foreign currency electronic fund transfer payments or low value payments out of the functional currency account instead.
Senior Advisor, APAC
Services, J.P. Morgan
Thanks to technology, simplifying bank accounts structures today can be achievable. J.P. Morgan’s Virtual Account Management, for example, allows clients to design a hierarchy of virtual accounts that centralises cash management needs into one physical account, yet providing segregation for the differing business activities and transaction flows.
Free up liquidity through automation
Trapped cash, or cash being held overseas by a company in different currency accounts, not only prevents liquidity from being fully optimised but also increases FX exposure. Often, the cash is kept there for local payments but otherwise remains idle and vulnerable to unfavorable currency market swings.
Adopting solutions that can reduce the incidence of idle cash can also help limit the FX exposure. J.P. Morgan’s Just in Time funding solution for example, enables clients to fund local currency payments automatically from a central currency account just prior to the time the payment needs to be paid. Because the solution is fully automated it also eliminates the need for treasurers to manually facilitate the FX conversion.
By taking the above steps, FX is effectively embedded into treasury management from end to end. This means FX risk management is no longer a separate task but instead tightly integrates within the account structure. Managing FX in this way removes pockets of cash in non-functional currencies where the currency exposure tied to any one position may seem small, but the aggregate exposure could be large.
Q4: Are there any current innovations (or on the horizon) that will change the way treasurers manage volatility?
Robotics Process Automation (RPA) – intelligent software that can automate human tasks – can be applied in a number of different ways to manage FX risks in cash management, including automating FX rate tracking. As an example, J.P. Morgan has applied RPA technology for a client in the commodity trading business to obtain real-time, instantaneous price quotations, allowing the firm to respond quickly to fast-moving currency markets. Other potential RPA applications include using bots to aggregate cash and exposure forecasts to help enhance visibility and drive greater efficiency in FX management.
The industry is also seeing greater adoption of Application Program Interface (API) technology to connect ERP or TMS platforms with banking channels to support the automation of FX booking and payment processes for greater transparency and execution accuracy. Another example of FX booking and settlement through API is to support global online e-commerce flows, giving retailers, aggregators and market places more flexibility when pricing goods and services, thereby providing better customer experiences.
While fairly nascent and evolving, the use of Artificial Intelligence (AI) and machine learning in the forecasting process can play a part in managing FX risks, particularly for scenario planning and stress testing of FX exposures.
To learn more, please contact:
Head of APAC Core Cash Management Product,
Treasury Services, J.P. Morgan
Senior Advisor, APAC Solutions,
Treasury Services, J.P. Morgan