Monday 19th Mar, 2018

The economy and how foreign exchange impacts the freight and customs sector

Photo: Jim Wilson
Photo: Jim Wilson

By definition the freight/customs industry is exposed to Foreign Exchange (FX) risk, as it deals with foreign currency receipts and payments. There are financial instruments available to mitigate these risks and the goal should be minimisation, allowing business to concentrate on core business.

To minimise exposure a business may have to FX risk, it is necessary to accurately ‘know your position’, to minimise risk. This is done through accurate forecasting of foreign currency cash-flows. Once this has been established there are financial instruments available mitigate exposure.

Once a position is established we need to then adopt a risk management policy that takes into account the economic cycle and the risk profile the company is comfortable with. Policy could be anything from doing absolutely nothing, which is a strategy, through to 100% cover for all foreign currency exposure. Ideally somewhere in between these extremes is where you set your policy.

It is this risk management process where one must consider the economic environment and the impact on currencies. The ability to absorb currency fluctuations, including profit margins, will determine how much protection is needed. The use of ‘forward contracts’, options and swaps are all instruments used to offset risk.

The Economic Cycle and the impact upon currencies

The economic environment, within which a company operates, is a major consideration to determine the direction of currencies and policy. It is therefore essential we have a cursory knowledge of this all-important environment.

The GFC (Global Financial Crises) ushered in a period of static growth and historical low interest rates. Central Banks set extremely stimulative monetary policy, globally, to encourage economic growth. This encouraged the flow of capital in to assets, causing bubbles, in search of yield. Global share markets, real estate and commodities all became the repository for the cheap money.

Western economies have slowly emerged from this economic stagnation. The US has led the way, with strong labour markets and improving growth data, allowing the Federal Reserve to begin the unwind of the massively expanded balance sheet. Monetary Policy has been extremely accommodating, around the world, with record low interest rates.

These low interest rates have provided cheap funds and currency wars. Interest rates drive currencies. The US Federal Reserve has been raising rates since 2017, along with the UK, in a return to ‘normal monetary policy’.

Growth has been reflected in inflation data (CPI) and rising rates are set to combat this new economic inflationary cycle. The EU, Australia and New Zealand are still operating in the previous cycle, with extremely accommodating monetary policy, awaiting more consistent economic recovery.

The US-led global economic recovery
The US recovery has coincided with the Trump administration’s ascension to office and by adopting a pro-growth strategy, has allowed the economy to flourish.

The major components to their pro-growth strategy are deregulation and tax cuts. Deregulation has opened up the energy sector, encouraging gas, oil and coal sourcing and production.

This has created a boom and turned the USA in to a net energy exporter, all the while, providing a cheap and reliable energy source for industry and the consumer. Tax cuts have ignited the business sector, allowing corporate earnings to jump, thereby sustaining share market valuations.

The tax cuts have also sparked reinvestment in business, driving expansion and increased growth. This has been reflected in record levels of consumer confidence and rising wages. US corporate earnings held offshore are said to be US$5Trillion and the Trump administration is bringing this home with a tax amnesty.

The tax holiday is an effort to encourage investment in US industry by allowing up front depreciation for re-investments. This will be a massive stimulus to the economy. Apple alone is set to bring back hundreds of Billions of US Dollars to reinvest in the US economy.

Trump has also embarked upon an overhaul of US trade policy. Multilateral trade has resulted in very inflexible systems that has seen huge trade deficits with many of their major trading partners.

Trump is now renegotiating the multilateral agreements into more flexible and ‘fair’ bilateral trade arrangements. The result may see a turnaround in the trade imbalance between the US and her trading partners.

The weapon recently unleashed was the return of the tariff. Trump imposed a tariff on imported steel and aluminium which has triggered strong rhetoric and the threat of a ‘trade war’.

That would be to no-one’s advantage and certainly not assist trade dependent industries such as freight and customs. The jury remains out on this one.

The rising interest rate environment in the US supports a stronger currency while the expansive monetary policy employed by the EU, Australia and New Zealand have a significant downside bias.

It is with this in mind that policy strategies should be considered. The core strategies of trade, tax and deregulation have unleashed a pro-growth economy that will allow the US to expand and fight growing deficits and debt.

Threats to global markets

Global debt is a growing threat to developed economies. The GFC was a crisis of leverage and debt which drove global economies into the worst recession since the Great Depression. The solution was government bailouts of banks and the record expansion of Central Bank balance sheets.

This extraordinary monetary policy reduced interest rates to historically low levels. This allowed national economies to continue to run massive deficits, adding to already enormous national debt levels, which are a growing threat to global economic stability.

As the global economic situation improves, inflationary CPI growth emerges, thus pushing interest rates higher. Debt servicing then becomes a threat.

The emergence of a new trade policy in the USA will have an impact on global trade as they remain the world’s largest market. The imposition of tariffs may be the first shot fired in a coming trade war or may just be a signal a return to bi-lateral trade agreements? Time will tell.

Geopolitical risks are always a clear and present danger to markets. North Korea has become a nuclear threat, while China threatens Asian borders in the South China Sea. The Middle East remains in turmoil while international terrorism is an ever-present threat. ‘Black Swan’ events are not predictable, by definition, therefore requiring contingency plans.

Paul Bettany is a Foreign Exchange Partner for Collinson & Co

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