Surging Dollar Spurs Jump in Corporate FX Hedging

The U.S. dollar's recent surge has significantly impacted the risk profiles of U.S. companies with foreign subsidiaries, devaluing their non-U.S. dollar revenues and reducing earnings. This has prompted many companies to reevaluate their foreign currency exposure and consider implementing or adjusting their hedging strategies. This article explores the implications of the surging dollar on corporate FX hedging and provides insights into effective hedging strategies for companies with varying degrees of foreign currency exposure.



The Impact of the Surge in the U.S. Dollar

The strengthening U.S. dollar makes it more expensive for U.S. companies to repatriate foreign earnings, leading to a decrease in overall earnings. This has prompted many companies to consider implementing or adjusting their hedging strategies to mitigate these risks.

Effective Hedging Strategies for Companies with Varying Degrees of Foreign Currency Exposure

1. Companies with no current FX exposure or unclear impact:
- *Strategy:* Consider implementing a new hedging program to manage foreign currency exposures.
- *Adaptation to current market conditions:* Instead of executing hedges as a knee-jerk reaction, develop a robust, thoughtful program that can benefit the organization long term. Consider fundamental questions such as "Should we be hedging?", "How should we be hedging?", and "Where does hedging fit in our organizational activities?" (Kevin Jones, Director, Treasury Advisory, Chatham Financial)
- *Example:* Medtronic, a US medical technology company, has improved its approach to net investment hedging by utilizing derivatives along with foreign currency debt and actively adjusting its FX risk management programs, instrument selections, and tenors to achieve broader risk diversification (Sheila Quintis, Vice President and Treasurer, Medtronic).

2. Companies with existing balance-sheet hedging programs:
- *Strategy:* Add a cash-flow hedging program to address fundamental mismatches between revenues and expenses brought on by currency fluctuations.
- *Adaptation to current market conditions:* Implementing these programs can be challenging due to difficulties in forecasting costs and revenue, especially in a foreign currency. However, a well-constructed program can deliver significant benefits, such as adding certainty to forecasted revenue and expense and avoiding wide swings in earnings.
- *Example:* TotalEnergies, a European energy producer, has adapted its risk management practices in response to market disruptions, including the COVID-19 pandemic and the Russian invasion of Ukraine. The company has focused on managing its financing front, liquidity provisions, and the expected volatility of various asset classes (Alexandre Dubé, Group Treasury, TotalEnergies).

3. Companies with existing FX hedging programs:
- *Strategy:* Reassess existing hedging programs to determine whether they are still functioning as intended.
- *Adaptation to current market conditions:* Perform a holistic review of the FX hedging program to determine whether making strategic or tactical changes will improve program performance or reduce the cost of hedging. This can help companies manage their risk profile more effectively and achieve meaningful cost savings.
- *Example:* Deutsche Bank Research report highlights the importance of the cross-currency basis, which indicates the amount by which the interest paid to borrow one currency by swapping it against another differs from the cost of directly borrowing this currency in the cash market. The report suggests that the cross-currency basis is far more important than previously thought and can significantly impact hedging costs (George Saravelos, Global Head of FX Research, Deutsche Bank).

Conclusion

The surge in the U.S. dollar has significantly impacted the risk profiles of U.S. companies with foreign subsidiaries, prompting many to reevaluate their foreign currency exposure and consider implementing or adjusting their hedging strategies. By understanding the implications of the surging dollar and employing effective hedging strategies tailored to their specific needs, companies can better manage their risks and protect their earnings from unforeseen shocks.