‘Uncertainty’ has emerged as the favourite word for corporate executives describing the prevailing business backdrop. According to first-quarter earnings calls analysis, use of the word or its variants hit a five-year high, surpassing mentions at the pandemic’s start in 2020.
Macroeconomic conditions and financial markets have become highly unpredictable over the past eight weeks as significant tariff threats on US imports loom over investors and companies, muddying the outlook globally. This has corporate treasurers defensive: as markets whipsaw and established correlations break down, hedging exposures and earnings becomes vitally important.
“Risk-off scenarios are now concurrent with a weaker dollar,” James Carolan, global head of institutional FX structuring at Deutsche Bank, tells Euromoney, noting that the dollar’s behaviour “signifies the potential for a broader structural shift in FX markets”.
The significant deterioration in corporate outlook contrasts starkly with the euphoric mood in January, at Donald Trump’s second-term start, when firms expected a global growth reset to buoy earnings. Instead, the US president’s tariffs strategy unleashed volatility and sparked historic moves in US Treasury markets, while sending the dollar downward.
At May’s end, the dollar heads for its fifth straight monthly decline, having shed 8.4% year-to-date against a basket of currencies. The rapid depreciation comes from historic highs: in February, corporates protected their bottom lines against a surging US currency. Now, they’re facing the opposite problem, with no volatility relief in sight.
US corporates’ hedge lengths and hedge ratios are the lowest since we started tracking them a year ago
Eric Huttman, MillTechFX
“This decoupling implies higher hedge ratios for international investors holding US assets may be prudent going forward, and has also driven increased demand for directional flows that allow clients to better navigate dislocations in the options market,” Deutsche’s Carolan says.
Meanwhile, perhaps more worryingly for those relying on established market trends, the so-called dollar smile – which refers to the buck climbing both in good times and during troubles – has stopped working. Corporate treasuries must adjust their behaviours, too.
This particularly affects companies in highly export-reliant economies, such as Taiwan and South Korea. In Taiwan, the local currency is 9% stronger against the dollar since early April, surging 5% on May 2 in the steepest rally since the 1980s.
For Taiwanese insurance companies, these moves raise the potential of nearly $800 billion of bets going sour, representing the amount of mostly dollar-denominated assets they collectively hold, with average hedging ratios below 60%, HSBC states.
Contemplating next steps, they risk further losses without increased hedges or must lock in current, unfavourable rates with them. This forces a complete rethink of business models, according to Bank of America strategist Chun Him Cheung, who said that “either way, the past business model has now shown itself to be unsustainable”.
Volatility spurs hedging activity pickup
At May’s end, the average tariff rate of US imports stood at 13.4%, according to JPMorgan strategists, who note that while easing US-China trade tensions and decreasing average tariffs from peaks lower recession risks to 40% from 60%, headline risks remain high.
“Tariff noise is never too far away,” the cross-asset strategy team, led by Fabio Bassi, tells clients. “President Trump threatened a sweeping 50% tariff on the EU (and a 25% levy on Apple). This unexpected volatility reinforces our call for range-bound risk markets and highlights the need for hedges against potential market disruption.”
HSBC’s head of Asia FX research Joey Chew also expects increased hedging activity from institutional investors, especially in Taiwan and South Korea, noting that the latter’s National Pension Service supposedly activated a ‘strategic’ FX hedging programme covering up to 10% of its $500 billion in foreign assets.
The rush to hedge dollar exposures comes after a stunned pause in April, David Macmillan, head of financial markets sales, corporates international at Commerzbank, tells Euromoney.
In April, during Trump’s trade reckoning, FX volatility soared, making hedging costs spike and forcing companies to wait out the market’s worst wobbles before committing to currency rates.
“Recent experience is that our large corporate customers did take a pause and step back from executing longer-dated currency hedging during April alongside the tariff announcements,” Macmillan says.
“After an observable pause in April, activity has returned to a more normalised level. Our guidance hasn’t changed – never be complacent, constantly seek product and trade execution that can give you an edge and seek hedging counterparties that are with you through all economic conditions.”
More hedging, more flexibility
While corporates traditionally used forwards contracts to hedge exposures, Deutsche’s Carolan says the bank saw an uptick in demand for optionality and flexibility as uncertainty continues.
“DB’s global FX structuring team observed an increase in demand for hedging flexibility, and our analysis on hedge optimization suggests incorporating options into portfolios can reduce variance and enhance performance relative to only hedging via forwards,” he adds.
“Whilst large structural market shifts take time to evolve, our clients have been increasingly looking at deploying such a mix of hedging strategies, layered across multiple tenors to balance risk, cost and tactical market views.”
There are always opportunities in times of market volatility; clients require our support during these times and we need to deliver
David Macmillan, Commerzbank
Flexibility is also a trend observed by MillTechFX, fintech affiliate of Millennium Global Investments, which surveyed 250 senior decision-makers for insights into changing behaviours.
“US corporates’ hedge lengths and hedge ratios are the lowest since we started tracking them a year ago, which means they’re protecting less of their exposure and for shorter periods, perhaps to build flexibility into their hedging programmes,” Eric Huttman, CEO of MillTechFX, writes.
But as optionality increases costs, some adjust hedging tenors, especially if the weak dollar favours their bottom lines, certainly true for UK companies. The pound benefitted from the dollar’s decline, spurring UK corporates to extend their hedging tenures as they rush to lock in favourable exchange rates longer. This appeared in survey results when asked about recent currency market volatility effects, with 85% of UK companies stating they benefitted, while more than half of US companies said they’d been negatively impacted.
“In recent weeks, several of our clients pushed their hedges out to the maximum available tenor as they looked to lock in protection and ride out near-term instability,” Huttman adds. “This makes sense, given extending hedges maintains the same level of protection against currency movements but without the need to book in profit and loss generated by short-term FX swings.”
In volatility, there is opportunity
“There are always opportunities in times of market volatility; clients require our support during these times and we need to deliver,” Commerzbank’s Macmillan says, adding that those suffering losses from lacking hedging programmes must ensure they do not compound negative effects by locking in rates at the wrong time.
Sarah Cattee, head of UK institutional FX sales and global head of HausFX sales at Deutsche, agrees, noting it is crucial to give clients tools to “review, optimise and scrutinise execution quality, market access efficiency and operational risk”.
Cattee tells Euromoney that clients are embracing automation, and some even outsource processes such as hedging, especially when these requirements are operationally “cumbersome”.
“Whether that’s an international corporate managing cross-border payables and receivables, an asset manager wanting to access EM onshore markets, outsourcing share-class hedging activities or a regional bank looking to offer similar services to their end-clients, Deutsche Bank has invested significantly in our HausFX product to meet the demand for flexible workflow solutions,” she says.
But systems are only one part of the battle, Commerzbank’s Macmillan says, pointing to challenges market ructions cause teams on both the client and sell-side.
“[A volatile market] can have its challenges,” he says. “I often liken it to the front-office sales teams acting as air traffic controllers dealing with multiple complex requests at the same time and our job is landing these transactions safely for both the customer and the bank.”
But if the “landing” is successful, it’s worthwhile.
“It’s great to see CFOs and CEOs of our customers speaking publicly about the hedges they have in place and know that we are a key provider to them,” Macmillan concludes.
