Tempests buffet the EU
The European Union is suffering immense pressures, externally and internally, buffeted by growing storms. The Italian crises has triggered fears of a collapse, with the populist alliance of the left and right forming government. The Northern League are of the right and the Five Star movement is of the left. The genesis of the alliance is anti-refugee, anti-EU and ‘Italy First’ economic policies. They propose to eject the more than half a million refugees, that have flooded the country, while focusing on a nationalist domestic policy. This is centred on a debt amnesty, blowing the debt/GDP restrictions imposed by the EU and investing in domestic growth-friendly policies. The alliance have stopped short of an EU exit but they are shaking up the status quo.
The right wing Spanish PM Rajoy has been forced to resign amidst another corruption scandal. This has allowed for the elevation of the Socialist minority leader, Sanchez, to ascend to the Prime Ministership. The new PM has minority support and has formed an unholy alliance with the pro-Basque and Catalan separatist parties. They have immediately demanded their pound of flesh, in the form of Independence, which have caused massive disruption to Spain and the EU over the last year. Storms are building with the Eastern EU members of Poland, Hungary, Slovenia and Austria. These Eastern members have adopted a right-of-centre nationalistic approach, all the while harvesting funding from the EU while thumbing their noses at them. The Hungarians and Poles have funded the rebuilding of their nations with EU development funds while rejecting compliance and outwardly rejecting their refugee policies.
To add to this witch’s brew, Trump has initiated a trade war, threatening access to the world’s largest economy for European exports. Trump has highlighted the inequality of the current trade system and imposed sanctions until a more balanced agreement can be reached. He has pointed out this is a war the US cannot lose, as they run massive trade deficits with the EU, China and NAFTA countries. These pressures are all mounting to threaten the very existence of the EU. The EUR has tumbled to below 1.1600, which is at the bottom of the recent trading range, severely testing key technical support levels.
Central bank activity and the impact on currencies
Central bank activity continues to play a major role in market direction and currency moves. The ECB is trapped in the extremely loose and stimulative QE program, employed since the GFC. The political developments have endangered the European fiscal, political experiment. The growing peril of possible ‘trade wars’ have added to the pressures. The extremely accommodative monetary policy is pro-growth but has undermined the strength of the currency. The Bank of England has resisted a return to a ‘normalised monetary policy because of the disruption of ‘Brexit’. Economic conditions in Australia remain testing and have prevented any action from the RBA. This is in stark contrast to the Federal Reserve in the USA. They have been raising rates over the last year or so with more to come. The return to a normalised monetary policy is a reflection of the robust and booming economy. Rising rates directly support a strong reserve, which should impose downward on the EUR, GBP and AUD.
In addition to the looming threats of a global trade wars, other international hot-spots continue to ferment. The North Korean nuclear crises have been atop the headlines, with an ‘on-again off-again’ peace summit scheduled for this month. This continues to disrupt markets and adds to the instability markets despise. Chinese military expansion in the South China Sea and meddling in the North Korea crises, spread disquiet. Sanctions imposed on North Korea by the USA have been extended to Iran. They are seemingly having the desired effect on one rogue nation so why would they not work with Iran?
Foreign exchange and risk management
Customs and freight is an industry heavily involved in international trade and thus is exposed to changes in foreign exchange. It is the management of this exposure that we seek to address by risk mitigation. This can be accomplished by the use of financial tools such as forward contracts, swaps and options. To address the risk a business must clearly delineate currency positions through accurate cash flow forecasting. Once the FX position is established we can then determine how much risk we need to mitigate. Currencies move with interest rates and these are a reflection of risk. A high growth economy is inflationary and thus drives interest rates upwards. The cost of borrowing money is at a premium and therefore demand is higher. Higher risk also impacts interest rates and currencies.
Geo-political developments drive currency movements as do macro/micro-economic events. We live in dynamic times and the pace of change seems to be gathering momentum. The Trump administration put a ‘cat amongst the pigeons’ in terms of global upheaval. The status quo is being challenged and upturned, with a vision of bilateral free and fair trade, combined with a seemingly revolutionary approach to international relations. Trump is negotiating international peace and trade deals, as he would a business deal, with all options on the table. Summary markets loathe instability and there is clearly plenty of global change afoot. The question is whether this will be positive, over the long term and how to protect your business from volatility in currency markets, in the short to medium term? Any risk that is not comfortable, should be eliminated and this is easily mitigated through the use of readily available FX tools.