As companies and manufacturers nationwide continue to extend their supply chains across emerging market borders in an effort to take advantage of these countries’ loose monetary policies, they must be wary of volatile markets that can ultimately damage their bottom line, a well-known strategist suggests.
Mark Frey, chief market strategist and risk specialist with Cambridge Mercantile Group, points to a recent warning by the International Monetary Fund to support his argument. The IMF recently forewarned that the same policies that encourage and promote investment are instead creating ticking time bombs for these economies.
For example, Frey says, look at China’s renminbi, which, after hitting record peaks earlier this year against the American dollar, recently dropped the most it has since 2011. Furthermore, an exit from monetary easing in regards to the Russian ruble and the Brazilian real is likely still well away.
Even the Canadian dollar, long considered a stalwart in the world’s seesaw economy of recent years, is “slowing down a bit,” Frey tells Industry today.
“Canada has sort of been the darling of the market for a long time,” he says. “The Canadian dollar and the Australian dollar are two currencies that have over performed the broader market because of their relatively sound fiscal environments, resources-based economies and have generally been stronger than other G-20 countries.”
He adds, “But as the world begins to slow from an economic growth perspective, for the first time in quite some time the domestic outlook in both Canada and Australia has turned even more negative than perhaps what it is in the US. There is a lot of risk in the broader marketplace, and that weighs heavily on some of the emerging markets. What that means is we get a lot more volatility in times like this than we would see in a steady state of growth.”
The good news is Frey expects the American dollar to “perform quite well over next year or two after being beat up very badly” over the last several years.
“We will see some significant US dollar strength going into the next year or two,” he says. “I see an opportunity where the US dollar trades very firmly.”
What the IMF is referring to, Frey suggests, is that “some of these currencies may be significantly overvalued or that there may already be too much production already being pushed toward these locations, and that those currencies might be vulnerable, especially if interest rates begin to increase materially.”
A MUST-HAVE COMPASS
Moving manufacturing productions offshore is nothing new, Frey says. It has been a trend, however perplexing to the domestic job market, for well over a decade, especially in terms of setting up operations in some noteworthy emerging markets with robust growth rates. China, of course, comes to mind. So does Russia, Korea, and Brazil.
However, as that movement has unfolded, Frey says he and his colleagues have noticed a troubling tendency among the North American firms they advise: Because these companies traditionally deal with foreign supplies in American dollar terms, they believe all legitimate foreign currency risks have been eliminated.
That is wishful thinking, Frey says.
“In many cases, arrangements are done in a US dollar centric manner,” Frey tells Industry Today. “Therefore, a firm in the US might think there are no currency risks because I am receiving revenues from my product that I sell to the mass market in US dollars and I am paying for my imported goods in US dollars as well.”
However, he says, a very real foreign current risk component remains. He illustrated a scenario where such a dilemma may unfold.
“Let’s say I am a manufacturer in an emerging market, such as Korea, and my cost base is local currency Korean Won. And let’s say I am billing my customer, which in this case is another manufacturer in the United States, in US dollars,” Frey describes. “If, for whatever reason, my currency becomes significantly more expensive, like if the Korean Won begins to appreciate materially, my cost base has to go up in my domestic currency terms. Therefore, I need to increase my US dollar cost base to my customer, probably through my prices.”
He adds, “So, even though they are paying in US dollars, if the Korean Won goes way up, we are going to be paying a lot more in US dollars for the same value of production for that Korean entity.”
In other words, if US-based manufacturers and corporations are dealing with foreign suppliers in US dollar terms, the local currency volatility remains extremely impactful to the pricing they receive and, therefore, their business’s bottom line.
This is why currency risk management is the ideal compass for navigating market volatility, Frey says. Many companies, he suggests, already have such management in place – especially now that a number of American-based manufacturers are again setting up shop domestically, where costs are far cheaper than they were about a decade ago.
Those who do not have currency risk management should get to it soon, Frey adds. Foreign currency borrowing has risen by over 50 percent in many foreign markets.
However, he warns that financial managers, in many cases, are not prepared for those unique situations where they may be exposed to foreign exchange rate fluctuations after a volatile market impacts its local currency and thus changes the prices companies received in US dollar terms.
“They (financial managers) only think in terms of ‘I am paying in US dollars, so therefore I don’t have currency risk,’” he says.
Now is the time, he says, to look at currency risk management, especially since central bank easing the US, Europe and Japan it not likely to end anytime soon.