Business owners have plenty of reasons to worry in 2020 and beyond from what could be a harsh recession in the aftermath of the COVID-19 pandemic. In the meantime, there are potentially more dangerous headwinds creating chaos in foreign exchange currencies, prompting the corporate desk working extra hours.
Problem #1: COVID-19 And Flee To Safety
At the most basic level, the COVID-19 pandemic will result in a worldwide shift towards currencies belonging to countries better positioned to navigate the storm. The U.S. dollar comes to mind as the Federal Reserve and government continue to take action to support its domestic economy at a level that is unrivaled at the global stage.
The dollar index, a measure of the greenback’s strength versus a handful of major global currencies, is trading near a multi-year high. Any global investor or business owner that collects revenue or dividends in U.S. dollars is in much better shape by default of being on the right side of the trade.
But each and every company of any shape and size that borrowed money in U.S. dollars will have a harder time paying back the debt. Just how much U.S. dollar-denominated debt is there across the world? At the end of June 2019, U.S. dollars credited to non-bank borrows outside the U.S. stood at $11.9 trillion.
Imagine being a small-and-medium size business owner and having to suddenly pay an extra 10% on American debt obligations? This is the reality for Australian and Canadian business owners as their respective currencies have weakened by around 10% against the U.S. dollar since the start of 2020.
Foreign business owners could eliminate much of the foreign exchange uncertainty by purchasing a forward exchange contract. Doing so allows an individual to hedge against uncertainties by agreeing to buy or sell a currency pair in the future at a pre-set exchange rate today.
Large-size and global enterprises could be in a better position given their ability to simply re-borrow cash anywhere in the world at rock-bottom rates. Unfortunately, lenders won’t be so accommodating to small-and-medium size businesses who are struggling in a new and uncertain environment.
Problem #2: QE Infinity And Beyond
Quantitative easing (QE) is a strategy in which a central bank buys longer-term securities from sellers in the open market. Doing so increases the availability of the total money supply that can be accessed by lenders and investors.
The U.S. QE program will be “open-ended” which implies an unlimited amount of asset purchases. To infinity and beyond, right? Normally, this would dictate potential weakness in the U.S. dollar moving forward which would bode well for business owners of all shapes and sizes who stand to benefit from a beaten up dollar.
But the negative potential impacts on the U.S. dollar from QE infinity is in part or fully offset by the fact that global trade and financial transactions are still mostly settled in U.S. dollars. At a time of a global crisis, the currency behind the world’s number one economy remains king. Some experts believe the U.S. dollar is even benefiting from a shortage of U.S. dollars in the global market, despite an influx of printing freshly printed cash.
A forward contract would also prove to be useful in this situation as it eliminates much of the guessing work involved in figuring out what direction the U.S. dollar will move. A business owner shouldn’t get caught up in the dangers of currency speculation given large currency swings in a turbulent foreign exchange market. Instead, they should focus on what they do best: running an enterprise.
Problem #3: Interest Rate Reductions
The U.S. Federal Reserve made a decision in early March that it will cut interest rates by half a percentage points to a new target range of 1.00% to 1.25%. As expected, the U.S. dollar immediately reacted to the downside as lower interest rates are by default less attractive for foreign investment.
Meanwhile, the Bank of Japan kept its interest rate unchanged at negative 0.1%. The fact that many top-tier global economies had their interest rates near zero or even in the red implies it has much less flexibility for further moves compared to the U.S. dollar.
Once again, a currency forward contract or other hedging tools can help business owners avoid foreign exchange losses by trying to guess which central bank has the most flexibility.
Bottom Line: Uncertain Times
Medical experts and scientists worldwide are adapting new information but there is just too much uncertainty in the world from COVID-19. Is a vaccine really 18 to 24 months away? Will one or some of the potential treatments being evaluated get approved in the near-term?
These are the types of questions that will impact global financial markets, from stocks and bonds to foreign exchange rates. The unprecedented level of uncertainty and risk dictates business owners need to take extra steps to secure their financial future and well being.