Risk Management

Three Currency Predictions for 2016

Volatility will no longer be the "new normal" but just the norm; it will be the "year of the yuan"; and FP&A teams will be pressed for insights.
Wolfgang KoesterDecember 21, 2015
Three Currency Predictions for 2016

The biggest currency story in 2016 will be the Chinese yuan becoming more closely tied to world currencies other than the U.S. dollar, and the very significant business risk that represents for multinational companies. But there will be other significant stories as well.

Wolfgang Koester

Wolfgang Koester

We are now in an environment where CFOs can no longer manage currency and the associated business risks by a version of the old “80/20 rule” (in this context, having a good [80%] understanding of the currencies impacting a financial statement). CFOs are awakening to the fact that the less-understood 20% may present very material risks.

Given that environment, corporate boards, CFOs, and CEOs will be seeking greater insight into how currency could impact business operations. In 2016, more than ever, corporate executives will need to know “what it means for [this element of our business] if [this currency rises/falls].”

Here are three currency predictions for 2016:

  1. Volatility will no longer be a “new normal,” but rather just “normal.”

Currency-driven business risks are a fact of life for multinational companies. In this year’s third quarter, for the fourth quarter in a row, negative currency impacts to corporate earnings were magnitudes above previous years’ averages, according to an analysis by FiREapps. Contrast this sustained volatility with 2012’s euro-driven currency crisis, which lasted two quarters and caused more than $40 billion of negative impacts to U.S. corporate earnings, according to research by FiREapps. It’s a different world now, and all indications point to this trend continuing into 2016.

In 2016 hot spots might include the eurozone, Russia, Japan, and Latin America.

The eurozone: Since mid-2014, U.S. multinationals have cited the euro as an impactful currency as often as they’ve cited all other currencies combined. The euro hit historic lows in 2015 as concerns about the eurozone economies persisted, new geopolitical risks arose, and the monetary policies of the eurozone and the United States continued to diverge (the European Central Bank continued its pursuit of quantitative easing, and the U.S. Federal Reserve tightened policy with an interest rate hike). Expect uncertainty, volatility, and a weaker euro to continue. While a weaker euro tends to negatively impact U.S. companies’ sales in Europe, it is volatility that makes planning such a challenge, which is likely to remain the case through 2016.

Russia: The ruble was incredibly volatile in 2015, rising 42% from a late-January low to a late-May high, then falling 25% by late August. Early in the year, we saw multinationals like General Motors go so far as to temporarily suspend operations in Russia, citing accelerated volatility. In 2016, Russia will continue to be a big question mark.

Japan: Though not nearly as much as the ruble, the yen exchange rate was also marked by volatility in 2015, bouncing between 118 and 126 yen to one U.S. dollar. The yen isn’t in position to strengthen next year; the Japanese economy fell back into recession, and most analysts predict the Bank of Japan will respond as it has been responding: with more monetary stimulus that subsequently drives down the value of the yen. A weak yen has significantly weakened corporate revenue, and multinationals should prepare for more of that in 2016.

Latin America: The Brazilian real and Argentine peso continue to be volatile. In 2015 through November, the real was down 29% (it fell 17% in the first quarter alone) against the U.S. dollar, and the peso was down 11.5%. This volatility has impacted U.S. multinationals, particularly producers of consumer products.

Relative to those currencies and others, the U.S. dollar is likely to continue to strengthen in 2016. Given the economic and geopolitical turmoil elsewhere in the world, the U.S. dollar will continue to be a safe haven and sustain an environment in which companies have to operate under a mandate to innovate and focus on quality, rather than produce the cheapest export/product possible. For U.S. multinationals, this means more business risk.

  1. China will further loosen its grip on the yuan.

Many multinationals are highly exposed to China’s yuan (the basic unit of the renminbi, or RMB, the country’s official currency, in much the same way that the British pound is the basic unit of pound sterling). But many haven’t been actively managing the currency and its associated risks. That was because of its close peg to the U.S. dollar, which meant there was little exchange-rate volatility for companies to worry about.

That changed on Aug. 11 of this year, when China surprised markets by allowing the yuan to fall by nearly 2% against the dollar. The decline continued in the following days, hitting a four-year low against the dollar. This led to volatility for many Asia-Pacific currencies as countries took action aimed at maintaining parity against the yuan. This tracks with what we’ve seen as the euro has weakened against the dollar. Volatility in a major currency creates a ripple effect around the world.

China is poised to further widen the yuan trading band in 2016, in large part because the RMB will become the fifth currency in the International Monetary Fund’s “basket of reserve currencies,” known as Special Drawing Rights (SDR) currencies. As China moves to a freely floating trading band (an expectation of the SDR currencies), the yuan will likely experience unprecedented volatility. In fact, the volatility we’ve seen in 2015 — and the associated business risk to corporates — will pale in comparison.

In 2016, for the first time, the yuan will be a risk that many multinationals will actively manage. While Morgan Stanley is calling 2016 “Yen Year,” I think “Yuan Year” will turn out to be a much more apt characterization.

  1. Boards, CFOs, and CEOs will look to FP&A for insights

Corporate financial planning and analysis (FP&A) teams will need to be prepared to answer tougher questions about how currency volatility will impact business operations. The questions will require granular, often time-sensitive currency data. Such questions may include:

  • What does it mean for the supply chain if the Brazilian real has another big first-quarter fall?
  • What does it mean for expenses if China widens the yuan trading band by another 2%?
  • What does the hike in U.S. interest rates mean for net income?
  • What does it mean for the cost of goods sold in Japan if Japan resumes active devaluation of the yen?
  • What does it mean for revenue if the euro falls to parity (1 euro = 1 dollar)?

Many CFOs have been asking these questions for the last six months. Until this point, FP&A had not had to be particularly involved with currencies, nor had they been asked to take a specific look at them, at least not to the level that they have to now. These kinds of questions are getting vastly more complex, and they surely will be harder to answer in 2016.

Wolfgang Koester is the CEO and co-founder of FiREapps, a provider of cloud-based currency analytics for corporate finance.