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Brexit: The Dollar story
Jeremy CookChief Economist and Head of Currency Strategy
Your Presenters
• What has happened?• What next?• Why hasn’t EURUSD crashed?• Political Risk• Policy Risk• The Elephant in the Room• What can you do?
Brexit: The Dollar Story
• Hard to imagine more testing circumstances for an incoming leader to face. Mrs Maywill need to unite a deeply divided country following the vote to leave the EU, bring together the opposing sides of the Conservative party and fulfil the task of actually taking the UK out of the EU and negotiating a strong deal for the country. On top of this, she has begun to set out the makings of a reforming policy programme, with proposed changes to corporate governance indicating a different attitude to big business and ‘The City’ than that of her predecessor.
• A 2nd referendum has been ruled out as has a near-term General Election
• Has limited Brexit fallout within her own party and quelled Scottish voices however her Cabinet appointments have raised eyebrows.
A New PM
• Pressure to invoke Article 50 of the Lisbon Treaty is increasing on a day-by-day basis but we do not think that it will take place this year.
• Her appointment of Messrs Johnson, Davis and Fox as Secretaries of Brexit facing departments is being seen as clever and insulates her Premiership.
• Canada has summed up the trade mood with Canada's International Trade Ministry releasing a statement saying that their first priority was to ratify the Canada-EU Comprehensive Economic and Trade Agreement. That was a clear sign that, despite the optimism, experts still warn any trade deal will take years to complete.
‘Brexit means Brexit’
‘Brexit means Brexit’
Source: Citibank
• Procrastination is seen as hurting the UK not just economically but also politically, as the EU legislative machine will rumble on without UK input. So far the EU has always been careful to keep the UK involved in discussions over new legislation, particularly when it comes to financial markets. Not anymore.
• Another clear view was that Britain will indeed exit the EU. No one sees any realistic possibility of the decision being reversed. Interestingly, few think the UK will move to join the European Economic Area, which might be the best solution from an economic point of view but wouldn't be politically acceptable in the UK. More likely, a UK-specific solution will have to be negotiated where limiting EU immigration would come at the price of compromised access to the single market.
• Europe is of course on holiday for a month now so the conversation will calm for now however terrorism attacks will not help anti-migration pressures.
Eyes in Europe
The timeline of politics
June 2016 Q3-Q4 2016 2017 2018
23 June: UK referendum result announced in Manchester Town Hall
24 June: Likely resignation of Cameron, triggering leadership contest
24 June (or shortly afterwards): UK formally make request to withdraw from EU and trigger article 50 provisions
Q3: Domestic Conservative party leadership contest/new PM to take officeQ3/Q4: UK and EU to establish working method/process and indicative timetable for “divorce settlement”
2017: Renewed pressure for Scotland and N Ireland to hold referendums on Independence / EU membership
Q3/Q4: Formal end of two year Article 50 Process. UK to formally cease EU membership unless extension agreed by agreement of all EU leaders.
Process of disengagement from EU including amendments to national law 2026?
Why hasn’t EURUSD crashed?
Political Risk
Policy Risk
• On August 4th the Bank of England fought back with cuts in interest rates to fresh 322 year lows and a slew of new policy measures. The 6 members of the MPC who voted for all the stimulus are treating the battle against a post-Brexit slowing of the UK economy like a street-fight; hit them first, hit them hard and make sure they don’t want to get up. This move by the central bank is that first punch.
• There had been some doubts that the data picture may not have given the Bank enough insight for them to begin a policy of stimulus; these were wrong and the combination of interest rate cuts, quantitative easing spending, including a corporate bond buying program, and a new funding scheme for banks make this a policy toolkit that is set to dig the UK economy out of any mire it may fall into as quickly as possible.
Policy Risk
• We would expect any increases in stimulus to weaken sterling to fresh multi-year lows, exacerbating the worsening of trade conditions in Europe. This would in turn slow growth on the continent and prompt a stimulatory impulse in the form of increased QE from the European Central Bank, possibly as soon as September.
• Additional euro weakening is contingent on further QE from the European Central Bank, however the already depressed nature of European government debt means that there is little extra room for yields to fall. This will act as a barrier to substantial declines in the single currency.
The Elephant in the Room
• One option represents the status quo, the other a radically different approach
• One option has laid out policy ideas, the other has depended on slogans and bluster
• One option is (and has been) the overwhelming favourite, the other is definitely the outsider accordingto polls and betting markets
• Immigration is the number one campaign concern• Both options are seemingly rather unpopular, according to polling.
• One option is completely priced in to asset markets, the other represents an almost unpriceable risk.
Foreign exchange risk arises when your company is exposed to a financial transaction in any form that is denominated in another currency. Your company can be exposed to this risk through a number of channels – most notably:
Risks
Transactional Translational Credit Risk Liquidity Risk
Forecasted FX Exposures
Balance Sheet Adjustments Default Risk Liquidity Events
Accounts Payable Foreign assets / liabilities Concentration Risk Margin Calls
Accounts Receivable Tax obligations Counterparty Risk
Capital Expenditure Foreign CCY loans
Significant Company Purchases/M&A
What are the risks my company could be exposed to?
How to visualise your risk-return trade off
-5.00% -4.00% -3.00% -2.00% -1.00% 0.00% 1.00% 2.00% 3.00% 4.00% 5.00%0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09DISTRIBUTION OF RETURNS
Returns above/below 0%
Pro
babi
lity
Probability distribution is one of the most effective ways to visualise the dispersion of your returns and your inherent risk. Depending on your portfolio of products, your dispersion, or distribution, of risk will differ. The probability distribution curves pictured show normal distribution. That is, the positive and negative risks to your portfolio are symmetrical and are equally as probable.
Having a riskier portfolio will increase the probability that your portfolio will result in excess returns/losses, and decrease the extent to which your returns are dispersed around zero – as shown by the green curve.
More Risky More RiskyRisk Neutral
LESS RISKY PORTFOLIO
MORE RISKY PORTFOLIO
100% Certainty0% Flexibility
Portfolio of spot and forward contracts
Protection with potential upsideProtection of a portion of the exposure
Forward contracts Spot deals
Fully Hedged Wholly unhedged
What are your risk mitigation objectives?
0% Certainty100% Flexibility
2012 2014 20150.675
0.725
0.775
0.825
0.875
A static program can be used to protect a budget rate by purchasing forward contracts to cover your budget rate for a chosen period. Upon a new time period, a new set of forward contracts are purchased to cover the following period.
Static Programs
Static Program
EUR/GBP
Disadvantages• You do not benefit if rates move in
your favour• As with a forward contract, you
may have to pay an initial deposit• If rates move against you, you
may need to pay a margin call in order to keep the position in place
Advantages• Allows you to forecast
transactable future FX rates
1Month: 2 3 4 5 6 7 8 9 10 11 12
Source: ECB Daily fix, World First DataNote: the above is an indication of past performance and is not a reliable indicator of future results.
Time Horizon: Long, Medium, Short term view
Selecting the length of your program is critical to ensuring you meet your risk mitigation objectives. Whether your business can forecast your exposure 3 months or 3 years in advance – we’ve got you covered.
How far forward do you require cover?
0 Months 6 Months 12 Months 18 Months 24 Months 30 Months 36 Months
Length of Risk Mitigation Program:
RISK MITIGATION PRODUCTS
INVESTMENTS AND FOREIGN EXCHANGE CAN GO UP AS WELL AS DOWN AND INVOLVE THE RISK OF LOSS. PAST PERFORMANCE WILL NOT NECESSARILY BE REPEATED IN THE FUTURE.
For many corporates, risk mitigation will have one purpose – to achieve a pre-determined budget rate. Your budget rate will be the rate you use to forecast your future international transactions (whether you’re paying suppliers, issuing invoices or exporting your produce) and will inform your company-wide forecasts on performance. Your attitude and flexibility toward this budget rate will inform your objectives:
Your Product Portfolio
Forward Contracts and Variations Will allow you to fix a rate for up to 3 years, based on the interbank exchange rate at the time of booking – this gives you a guaranteed rate at which to transfer up to the point at which the contract expires.
Spot ContractsAllows you to fulfil your payment requirements with minimal notice. You’ll know exactly how much you’re paying up front, and how much the recipient bank account is due to receive.
Questions
• These comments are the views and opinions of the author and should not be construed as advice. You should act using your own information and judgment.
• Whilst information has been obtained from and is based upon multiple sources the author believes to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed.
• All opinions and estimates constitute the author’s own judgment as of the date of the briefing and are subject to change without notice.
• Any rates given are ‘interbank’ i.e. for amounts of £5million or more thus are not indicative of the rates offered by World First.
• World First USA, Inc. is registered in the USA (Delaware State Division of Corporations file number: 4971976) and is registered as a Money Services Business in the United States with FinCen (MSB Registration Number: 31000069357644) and is registered as a non-depository financial institution with the National Mortgage Licensing System (NMLS#1018479).
Contact & Disclaimers
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