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Beyond Coronavirus: The Future of Market Volatility

Is this market volatility temporary or the new normal?

. It’s unclear when elevated uncertainty will subside but even as markets eventually calm – it won’t be indefinite.
. It’s unclear when elevated uncertainty will subside but even as markets eventually calm – it won’t be indefinite.

Right now, markets and businesses around the globe are struggling with the ongoing COVID-19 pandemic. Is this market volatility temporary or the new normal?

Key questions:

  1. Is the low volatility currency honeymoon over?
  2. Is volatility worse today than in the past?
  3. Does currency hedging help or hurt?

The first quarter of 2020 was marked by wild market swings, global uncertainty and the shutdown of normal day-to-day functions which led to cancelled conferences, work-from-home mandates and even quarantines of entire nations. The panic-filled environment has business owners wondering when and if markets will return to normal. This is of particular concern to SMEs and large companies with an international component. Not only is there a shift in consumer behavior, but both global supply chains and foreign currency are affected.

It’s unclear when the crisis will subside as medical professionals around the globe work for a solution and both governments and businesses take steps to limit the spread of the virus. Because of the threat to human lives around the world, it is hopeful that an end to the crisis will be swift.

The future of forex: expect the unexpected

The value of a country’s currency is surprisingly delicate, shifting based on inflation, interest rates and economic performance, among other factors. While FX volatility has generally been steadier in recent years thanks to lower inflation rates and expectations, even small movement can affect businesses with an international component such as overseas suppliers or staff. Additionally, recent history shows that long periods of low FX volatility are typically followed by significant instability. Though that remains to be seen, the coronavirus pandemic has obviously wreaked havoc on the global economy including causing shifts in bond markets and the forex market. It’s unclear when elevated uncertainty will subside but even as markets eventually calm – it won’t be indefinite.

Why is more market volatility on the horizon?

COVID-19 is undoubtedly the cause of heightened uncertainty that has destabilized global markets. Afterall, cases continue to spread across the globe and various industries, from travel to retail, are deeply affected. Yet in some ways higher volatility may be the new normal. Some argue that even if COVID-19 hadn’t spread, increases in volatility could still be likely due to uncertainty related to the upcoming US presidential election and the number of years since the last recession. Though the U.S. came into 2020 riding the longest bull run ever, it can’t last forever.

World events and geopolitical issues are also tied to market movement. Since 2000, events like the Ebola outbreak in 2014, Brexit in 2016, US-China trade war in 2019 and the Iran conflict of January 2020 have all caused uncertainty in the market. Today’s economies are more connected internationally than in the past, with global supply chains, worldwide travel and other factors making it more likely that incidents in one country will affect another.

Can exchange rates be predicted?

Like the stock market, much has been theorized about the possibility of timing foreign exchange fluctuation. Given recent trends in volatility, it’s understandable that even seasoned professionals would try to gain insight into where this market may be headed. Yet the forex market is near impossible to predict with any certainty. Perhaps more importantly, it’s not an area where businesses should focus their time and resources. Though foreign exchange exposure risk management is vital for any sized company with international ties, attempting to time trades is inefficient, not to mention futile.

How does currency volatility affect your bottom line?

As any business owner knows, it’s practically impossible to accurately predict sales for any specific time period. Though long-standing companies will have a general idea of their bottom line based on past performance, seasonality and other factors, there are so many dynamic elements that contribute to sales figures that owners must account for movement. This practice is made even more complicated by foreign currency. Many supplies are sourced from international vendors and partners, meaning that the true cost of materials can vary greatly month by month.

How volatility has changed

To a degree, volatility is normal. The Dow Jones, which began in 1896, has seen many ups and downs during its long history. Is volatility getting worse? Yes and no. Even before the emergence of COVID-19, the market experienced numerous dramatic single-day point declines in recent years. In fact, the top ten biggest ever losses were in the 2000s – many around the 2008 recession. Yet because the index increases in value, even a large point drop years ago would be much less worrying today. From a percentage point of view, larger losses were seen during the Great Depression.

Still, the advent of social media has brought a new contributing factor to volatility. Speculation, announcements and concerns can be spread instantly, triggering enormous market movements. Tweets from CEOs and government officials have both gained and cost listed companies billions in value after a single online message.

That’s not the only recent change. As populism continues to rise across the globe, shifts in political norms are becoming more regular. The UK Brexit vote and 2016 US election results are just two examples of this movement that caused uncertainty as markets struggle to price in this environment, which can force reactionary decision making.

What does this mean for foreign currency?

As markets tumble with coronavirus fears, so too may world currencies. Worse still, there’s no clear idea of when the health pandemic will come to an end. Consequently, foreign currencies will likely experience heightened fluctuation over near to medium term.  

Does currency hedging help or hurt?

Generally, most everyone who manages international payables or receivables may be vulnerable to shifts in foreign exchange rates. If a business purchases supplies from another country or pays overseas staff each month, they might have a set amount budgeted for the cost. Yet this figure must often be cushioned to account for any fluctuation between the currency pairs. Not only does this prevent accurate forecasting but it also ties up cash flow that could be used for other purposes. Hedging can help alleviate some of this strain as from a business perspective it eliminates uncertainty and allows for more accurate budget planning.

Still, there are some who hesitate to consider this option for managing currency exposure. Understandably, the pre-COVID-19 low-volatility environment made this less of a critical issue. Additionally, some businesses may have been reluctant to miss out on possible gains if markets moved in their favor. Of course, because neither outcome is guaranteed, it’s impossible to predict what – if any – those gains would be.

Organizations are often taken off guard with unexpected currency shifts, with 1 in 5 US companies and nearly one quarter of Canadian businesses simply absorbing the extra costs from this action, in the past year. This reaction, while understandable, is not sustainable and can drain a company’s cash flow.

It is important to consider a company’s objective with regards to their currency exposure. For many, it is simply to reduce risk and gain greater certainty over their foreign costs. This particular goal is widespread because of its simplicity: regardless of the business size, no organization wants to operate with their bottom line at the mercy of the fluctuating currency market. In this common case, hedging is a practical solution.

What’s next?

Though the current global pandemic is unprecedented, periods of economic volatility are not. Downturns are regular events, though the degree of severity experienced in the first quarter of 2020 is not typical. At the moment businesses and investors will simply have to wait until the virus outlook improves because government actions like stimulus packages and other relief efforts are temporarily boosting markets, until the pandemic clears these actions will not have a more permanent effect. It is useful for businesses to start considering a measure of volatility a normal part of forecasting – and start planning accordingly.