US-China trade tensions spilling over into currency markets or sudden volatility in an emerging market are the typical ways currency gyrations can hurt exporters. It’s why multinationals looking for peace of mind and certainty in their profit margin often hedge their currency risk. But for eurozone corporates exporting to the US, the impact of rock bottom interest rates on the cost of hedging their currency risk is reducing demand to protect their exposure.
German industrial groups, French car makers or Dutch food groups with large US markets typically buy euros forward for their hedging purposes. Expecting to receive dollars from US sales in a year’s time, they will sell those dollars and buy euros one-year forward in anticipation of converting those dollars to euros in 12 months as part of their hedging programme. Only low interest rates in the eurozone have thrown a spanner in the works.
The problem lies with the high euro dollar forward rates, explains George Saravelos, a strategist at Deutsche Bank. Forward rates are based off the interest rate differential between US and European Central Bank interest rates. They’ve diverged because of high US rates and negative eurozone rates as a result of different monetary policy, he tells GTR. “European exporters need to buy euros forward for their hedging purposes, but it’s got really expensive.” Three-month rates in the US are currently marked around 1.9%, compared to minus 0.4% in the eurozone.
Some exporters prefer to ride out the risk, and euro-dollar exchange rate volatility is at historical lows. Another reason companies don’t hedge their currency risk more widely is the cost, which can account for as much as 20% of the transaction in risky jurisdictions. It’s not that costly for European exporters, but the interest rate differential means those forward euros are now expensive. A one-year euro forward costs US$1.14, a five-year euro forward costs US$1.23 and a 10-year forward US$1.34, whereas the euro is trading at US$1.11 against the dollar. “These prices are a function of the rate differential between the US and Europe,” explains Saravelos.
On the flip side, US companies exporting to Europe have got it much easier, he says. “In the US, exporters can sell the euro and buy the dollar at very good levels. This has incentivised US companies that export into Europe to actively hedge and we are seeing significant demand from them for forward hedging.”
Low interest rates are changing exporters’ behaviour in other ways. Saravelos notes that European corporates aren’t rushing to convert their dollar receipts into euros. Instead, they are keeping those sales in dollars for a better return. “If they convert them into euros, they may have to pay negative rates,” he says.
He also notes that low interest rates in the eurozone are impacting bank behaviour. Eurozone banks are taking advantage of low rates by increasing their lending in a boost for trade. “We can see from the data that European banks are doing much more cross-border lending compared to a few years ago. Part of that may be for export finance and it supports foreign demand for European goods,” he says.
It is also encouraging companies to borrow in the region. “The amount of international corporate issuance in euros has exceeded dollar issuance for the first time, which is very unusual because the dollar market is larger and more liquid. Funding is so cheap in Europe it is incentivising the trend,” says Saravelos. Like Netherlands’ global information services group Wolters Kluwer, which launched a €1bn European Commercial Paper programme earlier this year for its short-term borrowing needs. “We tap negative short-term rates so that under this programme the company is actually paid for borrowing money,” says George Dessing, executive vice-president, treasury & risk at Wolters Kluwer. “Negative yields make a very special funding environment. Money is for free and I think it will remain so for quite a while.”