The Federal Reserve’s mixed messages on monetary policy are stoking volatility in the $4 trillion-a-day currency market, raising the odds that companies will have a harder time setting up exchange-rate hedges designed to protect overseas earnings.
“A low-volatility environment certainly is better,” Ulrich Leuchtmann, head of currency strategy at Commerzbank AG in Frankfurt, said in a July 16 telephone interview. “It would create problems if a high-volatility environment would be something permanent. This would certainly end up causing problems when people have to roll their hedge positions.”
After reaching its highest level in almost three years in May, the U.S. Dollar Index slid to about a four-month low and back up to a three-year high as Fed Chairman Ben S. Bernanke and other policy makers at the U.S. central bank alternately said they should and shouldn’t reduce their stimulus measures.
Implied volatility on one-month options for the dollar against the U.K. pound climbed this week to the most relative to six-month contracts since 2010. The euro and the Norwegian krone had similar moves, signaling that volatility is going to be at its most extreme in the short term.
Coca-Cola Co.’s second-quarter income was hurt 3 percent by swings in currencies, and that “headwind” is likely to increase this quarter, Chief Financial Officer Gary Fayard said on a July 16 conference call.
St. Jude Medical Inc., the St. Paul, Minnesota-based maker of heart-rhythm devices, yesterday reduced its forecast for sales for the second half of 2013 by as much as $20 million and earnings by about 2 cents per share after adjusting its assumptions for exchange rates.
EBay Inc. (EBAY:US) officials said on a conference call yesterday that a weaker euro and pound versus the dollar would temper earnings for the fiscal year.
International Business Machines Corp., the largest computer-services provider, said in its second-quarter earnings conference call yesterday that it sees a “currency headwind” in the second half of the year.
Philip Morris International Inc., the maker of Marlboro cigarettes, reported second-quarter earnings today that trailed analyst estimates after a stronger dollar cut overseas sales.
Companies use agreements to lock in future foreign-exchange rates, known as forward contracts, options to buy and sell currencies and other types of hedges to mitigate the effects of currency swings on revenue.
An advance in options implied volatility, a gauge of traders’ expectations of the pace of future currency swings, lifts the price of the contracts and boosts hedging costs for companies using them.
One-month volatility on the euro against the dollar exceeded that on six-month options by 17 basis points July 15. That’s the most since July 3, when it was at the widest since March 22. A similar measure for the dollar against the pound was 82 basis points July 16, the biggest gap since May 2010.
Bernanke said July 10 that the U.S. central bank would maintain a “highly accommodative monetary policy for the foreseeable future.” That was after he had said on June 19 that officials may start dialing down their unprecedented bond-buying program this year and end it entirely in mid-2014.
The dollar slid as much as 0.1 percent versus the euro yesterday before climbing as high as 0.6 percent as Bernanke said the central bank’s $85 billion of monthly bond purchases “are by no means on a preset course.” It appreciated 0.2 percent to $1.3108 per euro at 12:53 p.m. London time.
“Stop-go monetary-policy communication amongst some of the world’s most powerful central banks is leading to much volatility,” Chris Turner, head of currency strategy at ING Groep NV in London, said in a telephone interview on July 15.
“Most agree that the dollar is set for quite a decent rally,” he said. “But this is kind of like a race and we are still in the starting blocks. Bernanke sort of said, ‘on your marks, get set,’ and then went back to ‘on your marks’ with regard to the taper.”
The spread on the pound-dollar options narrowed yesterday after the Bank of England minutes showed policy makers voted unanimously against boosting their asset-purchased program, causing sterling to gain as much as 0.7 percent to $1.5268, the strongest level since July 4.
A JPMorgan Chase & Co. index tracking swings in Group of Seven-nation currencies averaged 1.4 percentage points more this month than it did in the first half. It’s averaging 10.7 percent in July, compared with a 9.4 percent average from the start of January to the end of June. Implied volatility on one-month euro-dollar options rose to 9.5 percent on July 3, the most since March.
FIREapps, a Scottsdale, Arizona-based company that advises clients and makes software to help reduce the impact of currency swings, said about 27 percent of 800 companies it surveyed noted that currency swings hurt revenue in the first quarter, compared with less than 5 percent two years earlier.
FIREapps said 213 of the companies reported negative effects on revenue from currency swings totaling $3.67 billion in the first quarter, according to an analysis of earnings conference calls.
“Based on our hedge positions, current spot rates and the cycling of our prior-year rates, we expect currencies to be a 4 percent headwind on our operating income (KO:US) for the third quarter and full-year,” Coca-Cola’s Fayard said two days ago.
That was after the world’s biggest soft-drinks maker, based in Atlanta, said profit dropped 4 percent last quarter.
“Unfavorable” foreign-exchange rates versus those that held the prior year reduced second-quarter sales by about $31 million, John Heinmiller, St. Jude’s executive vice president, said on the conference call yesterday. Revenue fell less than analysts estimated.
The dollar’s strength is contributing to a projected 1.5 percent decline in second-quarter earnings for nonfinancial companies in the Standard & Poor’s 500 Index, the second-worst performance since 2009.
Analysts see at least three more quarters of weakening for the yen and euro, cutting the dollar value of goods from Tiffany & Co. trinkets to Delta Air Lines Inc. tickets sold overseas.
A lack of policy clarity made movements in foreign exchange “choppy,” Caio Natividade, London-based head of foreign-exchange and commodity quantitative strategy at Deutsche Bank AG, said in a telephone interview on July 15. “Once there is more clarity on the path of monetary policy, measures of risk premium should compress again, and as that happens you will get better behaved currency movement.”
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