Dollar downturn sparks rise in hedging activity

The weak US economy and uncertainty over corporate governance in the wake of the Enron and WorldCom accounting scandals were cited as the main factors behind the lack of hedging at the time, but the greenback’s slide has provided a unique opportunity for US companies.

"The weakening dollar really works in favour of US multinational corporates," said Beau Cummins, global head of foreign exchange at Bank of America in New York. "Although there are problems with a weaker currency, corporates can now lock-in rates at favourable levels."

US importers are most affected by the weakened dollar, and have correspondingly proved to be the most active hedgers. Lynn Corsetti, managing director, forex derivatives marketing at Deutsche Bank in New York, said: "In terms of US importers that are long US dollar, we have seen a pick-up in cash hedging as a result of continued dollar weakness as well as the positive carry earned when selling dollar against most major currencies."

Non-importing companies, meanwhile, have slowed their cash hedging, but have increased their use of vanilla options as an FX hedging tool. One senior forex salesperson at a US bank in Chicago said: "These clients are becoming more proactive with their options portfolios."

While the FAS 133 accounting rules – which require companies to accurately mark derivatives positions to market - have reduced exotic options use, vanilla options are easier to fit to the accounting rules, said market participants.

Deutsche’s Corsetti said: "US multinational corporations with large overseas operations have increased the use of vanilla options in their hedge portfolios, as they allow companies to benefit from continued dollar weakness."

Some officials said one of the reasons for the lack of hedging in 2002 was that certain firms were overhedged due to expectations of a dollar decline, which did not begin in earnest until November.

But while worries over corporate governance have receded and the dollar has weakened, uncertainty over the economy remains, and the build-up of military tensions and geopolitical issues are at the forefront of companies’ concerns.

"There is a high correlation between the amount of hedges and projected sales, which in turn share a high correlation with the economy," said Corsetti.

While a multitude of geopolitical scenarios are possible, most analysts believe the dollar will weaken further. But the problem remains that the strength of other major currencies has not been based on economic fundamentals, and this uncertainty creates a problem for hedgers. The geopolitical issues are intertwined with worries over economic growth, and this situation is holding back the hedging increase.

One FX manager in New York said: "Once the dollar gets through the Iraq issue, there is the current account issue, and that does not play in favour of the dollar. The trend of a weaker dollar looks set to continue, and that’s not a bad thing. The consumer wants to consume and, at these levels, he can consume imports cheaper.”

For some non-US companies, the dollar’s decline has presented money-making opportunities. Australian latex manufacturer Ansell, for example, said last week that its hedging strategy would produce much higher revenues due to the strength of the euro. For every one cent movement in euro/dollar, the firm’s revenues move by about $1 million, Ansell chief executive Harry Boon said last week.

But some companies make a point of not hedging forex exposures. For instance, UK pharmaceutical major GlaxoSmithkline does not hedge translational FX risk despite more than half its sales being made in the US.

The firm last week reported its earnings per share would be down by 6% due to forex translations, but GlaxoSmithkline chief financial officer John Coombe said the company had no plans to change its policy of not hedging translational risk.

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