It seems that just about every country around the globe is looking to exports to help jump-start their economies. To do that, a few governments have taken steps to weaken their currencies, making their products relatively cheaper to foreign buyers.
Of course, China long has been a target of critics who charge that it keeps its currency, the yuan or renminbi, artificially low in order to protect its exporters. However, China's currency actually has strengthened recently â€“ just slightly, but still a move in the direction many outside the country want to see. In June, the yuan traded at 6.83 per U.S. dollar; today, it trades at 6.64 per greenback, according to x-rates.com.
At the same time, several other currencies, including those of Japan and Malaysia, have strengthened. In May, about 95 yen were needed to purchase one greenback. That number since has fallen to 81 yen, again according to x-rates.com. “Japan is an export-based economy,” notes Brendan McGrath, senior market analyst with Custom House. As with China, a weaker currency can work in the country's favor. Earlier this month, the Bank of Japan took several steps to weaken the currency, including cutting its benchmark interest rate and buying up Japanese bonds and other securities, as this New York Times article chronicles.
Malasia and Indonesia also have tried to maintain weaker currencies, McGrath notes. The Malaysian ringgit has fallen from 3.36 per U.S. dollar in May to its current level of 3.1 ringgits. Similarly, the Indonesian rupiah traded at 9,350 per dollar in May, versus 8,932 currently. “It seems like the major banks are all kind of singing from the same hymnal,” McGrath says. He's not suggesting collusion, but more a recognition that a weaker currency can help economies that look to exports for growth in jobs. It's not surprising that at least a few governments have taken steps to direct their currency's movement.
One result is that overall volatility in the foreign exchange markets has increased over the past few years. Although the markets have settled down from the extreme fluctuations seen during the height of the financial crisis in late 2008 and early 2009, the new normal is at a rate of higher fluctuations than was the case just 4 or 5 years ago. Previously, moves of 20 to 30 basis points were considered major, McGrath says. Today, moves of several pennies are more common.
The heightened volatility can play havoc with companies operating internationally, particularly if margins are tight. A hedging policy is critical, McGrath notes.
To be sure, he has a vested interest in promoting the benefits of hedging, as his firm helps companies develop hedging programs. However, the ability of a well-planned hedging program to reduce risk and enhance firms' value has been documented in a number of studies, including this one by researchers at Lancaster University Management School in the UK, and the University of North Carolina at Chapel Hill. In "The Effects of Derivatives on Firm Risk and Value," they write: “We find that hedging firms have lower cash flow volatility, idiosyncratic volatility, and systematic risk.”
At this point, it's difficult to say whether the Chinese will continue to allow the yuan to strengthen, even as other countries keep their currencies weaker. What does appear clear is that heightened volatility is the new way of life in the financial markets. ###