The volatility of foreign exchange rates and how it affects businesses

REASONS BEHIND THE VOLATILITY

Well, before jumping into “how”, let’s first talk about the reasons affecting the value of currencies, taking into account the current political and economic situation in the world.

Surely enough, there is a myriad of reasons why the exchange rate can be so volatile, and given the current climate, we can point out a few that are having a significant impact. For example, the Brexit deal taking over Europe, confirmation of the U.S. COVID-19 stimulus plan, and the steady progress of COVID-19 vaccines can all play a role in affecting the exchange rates worldwide.

Brexit Deal

Before the arrival of Brexit, when the United Kingdom voted to leave the European Union in 2016, the US dollar to British pound exchange rate grew stronger and stronger, year after year. Since Brexit, however, the pound’s value has been greatly affected in comparison to the Euro and the US dollar. Both the GBP/Euro and GBP/USD exchange rate took a plunge, with the GBP/USD exchange rate hitting a new low of $1.22.

Similarly, the Euro/USD exchange rate also took a hit when the United Kingdom voted to leave, as traders predicted that Brexit would weaken the European economy, and the Euro fell to $1.11. The trading markets then realized that the impacts of Brexit would take a long time to become apparent, and so the Euro steadily increased. The volatility of the Euro/USD exchange rate was not only caused by Brexit but also stems from the decisions made by the U.S. government and the Federal Reserve.

With the dollar being the world’s most traded currency, it is no surprise that it is seen as a safe-haven for investors during hard times. With Brexit and other global political developments, the demand for the dollar has increased, particularly in the UK, as it boosts investments following the uncertainty of finalized Brexit deals.

COVID-19 Vaccine Progression

Since the beginning of the coronavirus pandemic in March 2020, the dollar took on its safe-haven role, but as we begin 2021, it is expected that the dollar will continue to decline.

According to Wall Street analysts, the progression of the coronavirus vaccine is predicted to sink the dollar further as it promises high hopes for the global economy to return back to working order. This is due to the US dollar being a “countercyclical currency”, this meaning that as economic growth increases, the dollar weakens.

As the rest of the world is becoming more optimistic about the future and economic growth is accelerating, riskier investments are taking place elsewhere. So, investors will start investing in other currencies once more, hence weakening the dollar.

COVID-19 US Stimulus Package

In January 2021, President-elect Joe Biden announced his $1.9 trillion stimulus package aimed to boost the U.S. economy following the hardships of the coronavirus pandemic.

As previously mentioned, the US dollar has been weakened, and this is also down to the abundance of monetary and fiscal policies put in place in the US since the pandemic started to help curb the effects of the virus. The Biden Stimulus check, combined with the optimism over the vaccines and warmer weather, is expected to see the US dollar continuing to depreciate as the international markets look to trade in other currencies.

THE EFFECT OF VOLATILITY IN EXCHANGE RATES ON BUSINESSES

International trade is the most clear-cut scenario of how fluctuations in exchange rates can severely affect businesses. It’s far from a secret that Forex, or foreign exchange market, just as other kinds of volatility, can work either in favor or against a business depending on whether the country has weak or strong currency.

The most typical example would be Japanese companies that import/export products or import raw materials to produce their own products.

Let’s say you own a company in Japan and import products from Europe. In case the JPY to Euro rate increases, you will make more money without any additional price alterations. If, however, you export products, it will get more expensive and unprofitable in the long run.

Given the current circumstances, Forex works against businesses importing from or exporting products to European countries.

Another category of individuals that should be cautious of the fluctuations in the exchange currency rates is those who export their services to other countries while being located in Japan and receive US dollar-based payments. As the panic of the pandemic is being subdued and economic growth is on the horizon, the US dollar will continue to be under pressure which will eventually result in lower payment fees when exchanged to JPY and can significantly affect the life quality.

For investors, it is key to keep an eye on their exposure to the US dollar, perhaps moving back towards their base currency or increasing their investments in other foreign currencies (Canaccord Genuity 2020). This is due to analysts speculating that the “greenback is losing its appeal” as the world’s most traded currency (HaloFinancial). The aftermath of the predicted continuation slump of the dollar includes growth and disinflation worries for economies outside of the US, and so international markets should take caution.

SUMMARY

Gone are the days when the US dollar was the most traded currency? Perhaps yes, or perhaps no.

But for sure, the volatility of the exchange rates is mostly seen as a net negative for most enterprises and is rarely desirable despite all the potential to work in the best interest of a business temporarily.

Why? Business decisions are usually made on long-term planning, making the long-term predictability better than the volatility that temporarily favors them.