The soaring U.S. dollar, up at more than a two-decade high against the Euro so far this year, is leading to dislocations in America’s international trade profile as the muscular greenback makes imports cheaper for American consumers but makes exports of American goods a lot less competitive and more expensive in world markets.
There is an exception to this in the price of commodities because most major commodities are priced in U.S. dollars. Out of a list compiled by Bloomberg of 45 major internationally traded commodities, 42 are priced in U.S. dollars, including oil, wheat, soybeans, and many metals such as zinc, copper, aluminum, and gold.
And while economists agree that over the long term a strong U.S. dollar is a positive, sharp moves higher like those that have occurred in the U.S. dollar this year can wreak havoc on American companies involved in international trade.
Two years ago, the U.S. trade deficit was running at slightly more than $50 billion a month. Since then the deficit has ballooned along with the value of the U.S. dollar, more than doubling since 2020 to about $110 billion in March, a record.
Economist Gary Shilling, president of consultancy A. Gary Shilling Associates and a long-time observer of currency markets, wrote in an article for Bloomberg News, “The detrimental effects of a robust buck on American multinationals are shown in the foreign trade numbers. Since the beginning of 2020, U.S. exports have risen from $2.46 trillion to $2.91 trillion but imports jumped from $3.01 trillion to $4.22 trillion. So, the foreign trade deficit expanded from $546 billion to $1.32 trillion.”
Earnings for the second quarter remain strong overall, as they are expected to have increased by 10% from a year before. That figure, however, may have been around 12% were it not for the effect of a strong dollar, Jonathan Golub, head of U.S. equities strategy at Credit Suisse, told the Financial Times, adding that every 8% to 10% increase in the trade-weighted dollar index cuts roughly 1% off S&P 500 earnings.
Hedging Against Currency Risk
In the United States, there are few companies where currency movements have more importance than Aflac, the Columbus, Georgia-based supplemental insurer. Aflac generates 70% of its revenues in Japan, making the movement of the Japanese yen in currency markets arguably one of the most important risk factors the company faces. The yen recently traded at a record low against the U.S. dollar, making a successful hedging strategy all the more important for Aflac.
And the yen is the currency that has performed the worst against the U.S. dollar, especially this year because the Bank of Japan has been fighting decades of stubborn Japanese deflation. Therefore, Japan has not felt the inflationary pressures that much of the rest of the world has had to contend with and is the only major central bank to maintain an easy monetary policy in the face of the U.S. Federal Reserve’s aggressive monetary policy tightening this year.
Aflac has one of the most extensive hedging programs of any U.S. company, because there are few if any, large corporations that generate that large a percentage of their revenues in a foreign currency. And since the yen has been the weakest currency against the greenback, reaching more than a record low against the dollar, Aflac CFO Max Brodén told the Wall Street Journal that hedging these days for Aflac has been particularly important.
Parts of the hedging program, which is designed to protect the value of the company’s Japanese business, have been in place for more than two decades, with other parts added in 2018. Aflac considers itself to be well hedged but admitted currency movements could continue to put downward pressure on Aflac earnings if the yen remains under pressure, which is expected as few see any impediments to the U.S. dollar's advance in world currency markets, especially the yen.
Companies with much smaller exposures for foreign exchange risk can either hedge that risk fully, partially, or not at all. And hedging against risk can be very costly, so it’s important that companies get quotes on forward contracts or futures or swaps or whatever instrument they decide to use from more than just one market maker, says Matt Marshall, director of market analytics at Aegis Hedging, a company that offers hedging services.
Currencies trade over the counter so there can be widely different bid/offer spreads between banks and thus a company can wind up paying way too much for the hedge.
If too much is paid it could wind up negatively impacting the company’s cash flows and beginning a vicious, negative cycle of constantly damaged cash flow which takes away resources for other things the company may need.
Editor’s note: This is part two of a two-part series. You can find part one here.