What Matters Today: Managing the Risks of Foreign Exchange

Transcription

1 September 9, Treasury Services What Matters Today: Managing the Risks of Foreign Exchange Robert Wade Executive Director J.P. Morgan Treasury Services Foreign Exchange Matt Matthews Managing Director J.P. Morgan Investment Bank Foreign Exchange Gabriel de Kock Executive Director J.P. Morgan Investment Bank Foreign Exchange

2 Table of Contents Market Perspective 3 FX Risk Management 19 Treasury Challenges & Best Practices 6 Page JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 1

3 Overview The foreign exchange lscape is constantly evolving; market dynamics introduce challenges, as well as opportunities. Exchange rate risks are real need to be managed. Many currency drivers are outside of a company s control. Corporations should apply best practices to manage the risks associated with cross-border payments to address the complexities challenges of the market lscape. JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing

4 USD: From Offense to Defense As The Global Economy Takes Off Real Narrow Trade-Weighted USD US-G-9 1-Year Yield Spread, 197-Jul 115 USD (Left Axis) Spread (Right Axis) JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 3

5 USD Decline Driven by a U-Turn in Capital Flows US Purchases of Foreign Stocks via Retail Mutual Funds ($bn, 4-wk. m.a.), 199-Sep Flows (Left Axis) USD TWI (Right Axis, Inverted) JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 4

6 With Cash Coming Off the Sidelines Investors Underweight Risk Cash Cash Holdings Holdings of of US US Retail Retail Institutional Institutional Investors, Investors, Aug Aug Week Change (Right Axis) Global Global Portfolio Portfolio Weightings Weightings of of FI, FI, Equities Equities & Cash Cash (Pct), (Pct), Jun Jun E E Total (Left Axis) Jan- 6 Jul- 6 Jan- 7 Jul- 7 Jan- 8 Jul- 8 Jan- Jul Cash Fixed Income Equity JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 5

7 Global Production Capex Turn Recovery with Legs Ratio of Global PMI New Orders/Inventories Global (3m % Chg, saar), 1999-Aug G3 Capital Goods Orders & Global Capex (3m/3m Q/Q SAAR), -Jun PMI Orders/Inventories (Left Axis) Industrial Production (Right Axis) Capital Goods Orders (Left Axis) Global Capex (Right Axis) JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 6

8 FX Winners Losers in a Global Recovery Real Real Trade-Weighted Trade-Weighted Currency Currency Response Response to to a 1% 1% Increase Increase in in World World Industrial Industrial Production Production JPM JPM GDP GDP Forecasts Forecasts (Yr/Yr (Yr/Yr Pct Pct Chg), Chg), USD JPY CHF EUR NOK SEK NZD GBP CAD AUD US Euro Area Japan Dev Mkts China India Lat Am EM Asia EM Europe World JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing

9 Positions a Near-term Challenge for USD Bears Speculative Speculative Net Net Long Long USD USD on on IMM, IMM, Sep Sep Speculative Speculative Net Net Long Long EUR EUR on on IMM, IMM, Sep Sep Speculative Speculative Net Net Long Long JPY JPY on on IMM, IMM, Sep Sep 5 5 Speculative Speculative Net Net Long Long CAD CAD on on IMM, IMM, Sep Sep JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 8

10 Monetary Policies: The Risk of Policy Mistakes Exit Volatility Euro Euro Area, Area, Japan, Japan, UK, UK, US US Monetary Monetary Base Base (Yr/Yr (Yr/Yr Pct Pct Chg), Chg), 1-Aug 1-Aug Fed ECB BoJ BoE Narrow Narrow Effective Effective JPY JPY Japan Japan Core Core CPI, CPI, Core CPI (Left Axis) Narrow Effective JPY (Right Axis) QE policies have ballooned the Fed s BoE s balance sheets. Rapid base growth is no guarantee of currency depreciation. But the combination of QE aggressive fiscal stimulus is. Markets still fret about inflation risk, but messy exits from QE likely will be the more important currency ( vol) drivers in 1, as was the case with Japan in April-June 6. Japan Japan Bank Bank Current Current Account Account Balances Balances (JPY (JPY trn) trn) USD/JPY, USD/JPY, USD/JPY (Lef Axis) Current Account Balances (Right Axis) Jan-5 Jul-5 Jan-6 Jul-6 Jan-7 Jul JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 9

11 Inflation Risks are Minimal Global Global Unemployment Unemployment Rate Rate (Pct), (Pct), Q Q 1F 1F Global Global Capacity Capacity Utilization Utilization (Std (Std Dev Dev from from Avg), Avg), Q Q 1F 1F Developed Markets Emerging Markets Developed Markets Emerging Markets JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 1

12 Structural Fiscal Deterioration Not Just in the U.S. US: Genl Govt Deficit Debt (Pct of GDP), 4-13F EMU: Genl Govt Deficit Debt (Pct of GDP), 4-13F 14 1 Deficit (Left Axis) Debt (Right Axis) Deficit (Left Axis) Debt (Right Axis) UK: Genl Govt Deficit Debt (Pct of GDP), 4-13F Japan: Genl Govt Deficit Debt (Pct of GDP) Deficit (Left Axis) Debt (Right Axis) Deficit (Left Axis) Debt (Right Axis) JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 11

13 Goodbye Global Imbalances US US Current Current Account Account Deficit Deficit (% (% of of GDP), GDP), 198-1Q 198-1Q US US Sectoral Sectoral Balances Balances (% (% of of GDP), GDP), 197-1F 197-1F Priv Balance Net Foreign Lending Govt Balance JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 1

14 GBP Weighed Down by Dovish MPC, JPY s Lift from Trade Turn EUR/GBP EUR/GBP UK-EMU UK-EMU -Year -Year Yield Yield Spread Spread (bps), (bps), Sep Sep Japan Japan Trade Trade Balance Balance (JPY (JPY trn) trn) US-JP US-JP --Year --Year Yield Yield Spread Spread (bps) (bps), UK-EMU Yr Spread (Left) EURGBP (Right, Inverted) Jan-7 Jul-7 Jan-8 Jul-8 Jan- Jul Trade Balance (Left Axis) US-Jpn Spread (Right Axis) JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 13

15 Not All Commodity Currencies Are Created Equal Real Real Commodity Commodity Price Price Indices, Indices, 1947-Jul 1947-Jul CRB Metals FIBER Industrial Materials Foodstuffs CAD CAD Commodity-Price Commodity-Price Valuation, Valuation, 1994-Jul 1994-Jul USD/CAD Model Estimate/Forecast NZD NZD Commodity-Price Commodity-Price Valuation, Valuation, 1994-Jul 1994-Jul NZD/USD Model Estimate/Forecast AUD AUD Commodity-Price Commodity-Price Valuation, Valuation, 1994-Jul 1994-Jul AUD/USD Model Estimate/Forecast JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 14

16 CNY Short-Term Constraints, Long- Term Appreciation USD/CNY CNY NEER, 7-3 Sep Japan, Japan, Korea, Korea, Taiwan Taiwan China: China: Relative Relative Price Price Level Level vs vs Relative Relative pc pc Income Income (vs (vs US), US), Japan China Taiwan Korea Relative Price Level Jan- 7 USD/CNY (Left Axis) Jul- 7 Jan- 8 Jul- 8 Jan- Jul- 118 CNY NEER (Inverted Scale, Right Axis) Per Capita Income as % of US JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 15

17 BRL: Commodity & Macro Improvement - Capital Inflow Turnaround.6 USD/BRL USD/BRL Brazil Brazil Commodity Commodity Price Price Index, Index, Aug Aug 8 GDP GDP & IP IP (q/q (q/q saar saar %), %), 6-Q 6-Q BRL (Left Axis) Commodity Price Index (Right Axis, Inverted) 1.4 Jan-7 Jul-7 Jan-8 Jul-8 Jan- Jul Industrial Production (Left Axis) GDP (Right Axis) Foreign Foreign Portfolio Portfolio Investment Investment in in Brazil Brazil ($ ($ bn), bn), Net 8-May 8-May Net FX FX Flows Flows CB CB Intervention Intervention ($ ($ bn), bn), 6-May 6-May Equities Fixed Income Net FX Inflow Intervention Jan-6 Jul-6 Jan-7 Jul-7 Jan-8 Jul-8 Jan- Jan-8 May-8 Sep-8 Jan- May- JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing -1 16

18 Many Currency Drivers Are Outside of a Company s Control in an Environment Where Volatility Is Here to Stay JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 17

19 Making The Case for Foreign Exchange Risk Management Two broadly accepted reasons to hedge currency risk Hedging to reduce the volatility that exchange rate changes introduce in reported earnings Hedging to reduce volatility that exchange rate changes have on cash flow Academic, anecdotal empirical evidence strongly indicate that reducing volatility in reported earnings cash flow increases firm value, measured by the total return on the firm s stock In addition to direct exposure to earnings cash, currency movements can introduce economic risk to the firm, such as competitive pressures However, the ultimate objective of a corporate currency hedging program is to protect shareholder value By reducing the impact of exchange rate movements on earnings cash flow the firm reduces the economic risk shareholders face when they invest in the firm s stock JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 18

20 I Am billed in USD / Sell in USD.I Do Not Have Currency Risk When U.S. companies send USD abroad, they shift the responsibility for currency conversion to their vendor. Disadvantages of doing this are: May pay inflated prices to compensate vendor for taking on FX risk No control of FX risk Vendor may raise prices if FX rates move adversely they are unhedged Risk of payment delays When U.S. companies receive USD for international transactions, they shift the responsibility for currency conversion to their customer. Disadvantages of doing this are: Lost sales opportunities No control of FX risk results in inconsistent market share Risk of payment delays JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 19

21 Assessing FX Risk Requires Delineation of The Types of FX Risk Transactional Risk Transactions denominated in a foreign currency are settled at a different exchange rate than they were initially recorded at or subsequently revalued to Firm Value Translational Risk Translation of foreign currency denominated balance sheet income statement items Forecast Risk Earnings risk associated with forecast variances that result from exchange rate fluctuations JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing

22 Market Observations Transaction Risk: A large percentage (estimated to be around 9%) of the firms we have seen hedge trade receivables/payables intercompany balance sheet items Most firms that hedge this risk will try to cover 1% of trade receivables / payables in the liquid currencies mostly use forwards Forecast Risk: We estimate that more than 7% of these firms also hedge forecasted cash flows This percentage is increasing, but is usually dependent on the level of comfort the company has with their forecasts the competitive lscape (ability to raise sales prices) Most firms in this group hedge between 5% 8% of their forecasted cash flows Translation Risk: Split into two categories Earnings translation very few firms hedge this risk due to hedge accounting constraints. However the current trend is to hedge earnings by executing hedges of specific cash flows as surrogates Foreign subsidiary balance sheet translation - protecting the USD value of foreign cash held on the balance sheet of foreign sub More firms are starting to hedge this risk JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 1

23 Identify the Impact of Currency Movements on Earnings Cash Flow Forecast Risk Transaction Risk Earnings Translation Risk Budget Sale/Expense Cash Flow Translation at Consolidation Forecast risk Represents a strategic currency risk Hedge accounting implications Tenor of hedges generally six months to five years Represents an economic risk to shareholders Transaction risk Impacts earnings below the line on the FX G/L line Non-strategic currency risk Can be viewed as a point in time (one month at a time) exposure Translation risk Line-by-line translation of foreign subsidiary income statement Impacts earnings above below the line Represents an economic risk to shareholders Exposure can be managed with forward contracts / options as part of a Strategic Hedging Program Exposure can be managed with forward contracts as part of a Tactical Hedging Program Exposure can be managed by using proxy hedging of Forecast Risk as part of a Strategic Hedging Program JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing

24 Forecasted Exposure Hedge Framework; What Tenor How Much Discretion? J.P. Morgan recommends a policy that mates discipline in hedging forecasted cash flows. The policy could also allow for a measure of discretion within that discipline. Discretion on whether the Company hedges to the minimum required by its policy or up to the maximum allowed in any given quarter Some discretion on layering trades intra-quarter: when does the Company add a layer how much? Ability to layer further out than required 1% 9% 8% 7% 6% Minimum mated by policy Discretion between minimum maximum mated by policy 5% 4% 3% % 1% % Matory % Hedged Layer E Layer D Layer E Layer C Layer D Layer E Layer B Layer C Layer D Layer E Layer A Layer B Layer c Layer D Layer E Q1 (current quarter) Q Q3 Q4 Q5 Q6 5% 4% 3% % 1% *** Assumptions: sliding scale minimum base level, decreasing discretionary maximum level, 15-month hedging tenor JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 3

25 Treasury Challenge: Disconnected Workflow for Managing FX Exposures Across Businesses Treasury Operations External transactions Dealing Bank Characteristics: Business Treasury operations not always linked Decisions Analysis TMS Treasury Treasury processes are manual, with spreadsheets, faxes, s phone calls Consolidation Reporting Cash Cycles Business Operations ERP Payments Business Bank Data gathering is key unless accurate data can be obtained, exposure management hedge decisions, as well as liquidity decisions, may not be optimal Need: Visibility & control for both Treasury & Business Units JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 4

26 Integrate Business Process Into Risk Management Activities Tools for the business Control parameters set by Treasury Forecast Period Accounts Payable/Receivable Payment Processing Typically on company s ERP system FX Risk to be managed MOVE CASH (PAYMENTS) Transaction Balance reporting Input/execute individual instructions Input bulk or individual instruction PRE - TRADE Data analysis Cash balance to be managed TRADE Deal execution CONCENTRATE CASH Gather liquidity POST TRADE Deal settlement INVEST CASH Treasury ultimately manages the risk & the cash JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 5

27 Best Practices Advanced knowledge of cash flow timing currency Data extracts from the company ERP, A/P or A/R systems Consolidated bank statements Data submitted by subsidiaries Forecasts by currency into the future» Organize forecast data by functional currency sub, for revenue expense in each currency Information available on payment receipt transactions across subsidiaries Same day next day notification of all transactions balances Data transparency across inter-company payables receivables Amounts reported in local foreign currency Browser based tool allowing: Multiple distributed subsidiaries to deal with central treasury center(s) Center to execute deals in a wide range of currencies instruments Central or distributed back office processing view of deals executed Automated sweep of multiple currencies from distributed subsidiary company accounts Automated conversion to a target currency Management of inter-company loans investments JPMorgan Chase & Co. All Rights Reserved. JPMorgan Chase Bank, N.A. Member FDIC Design by TSS Global Marketing 6

28 Thank You Treasury Services

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