To Hedge or Not to Hedge – Part 2

Discussion and Analysis by Charles Porter

Today our social media interactions indicated an uptake in hedging options including the use of forward contracts. Specifically, corporations concerned about their exposure to import markets and international firms vulnerable to payroll and exchange transactions are seeking insure against downside risk and exchange rate fluctuations. The present uptake in hedging is explained by the strength of the Pound against the Dollar and, to a lesser yet significant extent, the Euro. This article concludes in favour of the appeal of hedging for your corporate and personal currency exposure.

Part Two – Is hedging advisable; are we at the peak?

Having produced an analysis of a post-Brexit Sterling devaluation in part one, the second part of this article seeks to understand whether Sterling’s present value is derived from a correction of the negative, post-referendum, currency effects. This in turn will inform a conclusion in favour of, or against, further hedging based upon whether the value is likely to be sustained or short-lived.

The value of hedging will therefore be partially determined by whether the pound’s current strength is a restoration of certainty or breakthrough on Single Market access. This will identify whether the pound’s strength is likely to be sustainably valued in the short and medium-term, or whether the present value is overweight and should be capitalised upon through hedging. Ultimately, we conclude in favour of the latter option.

Sterling’s current strength appears to be derived from short term shuffling by central bankers. An overwhelming volume of dovish central bank policy announcements have been accompanied by surprisingly hawkish statements. In fact, much of the pound’s revaluation has been propelled by speculation over future interest rate hikes and the reduction of monetary stimulus taking the form of a tapering of the asset-purchase program, quantitative easing.

The shift around mid-September that pushed, for example, Sterling-Euro through the Pound’s resistance level and Euro support levels was monetary policy rhetoric. Whilst the predominant rate-hike rhetoric was empirically supported by rising inflation and low unemployment, the overwhelming currency shifts based upon Sterling strength came from the words of individuals. For example, a characteristically dovish member of the Bank of England, Gertjan Vlieghe, spoke in London suggesting a Bank Rate adjustment “in the coming months”.

Furthermore, it is unlikely that the Florence Speech of Theresa May, UK Prime Minister, will be considered by the EU27 to be at all sufficient to progress with second round – future relationship arrangement – talks. This will be true should a back-door translation of May’s speech within the confidential meetings of UK and EU negotiators not facilitate progress and guarantees. Progression seems likely given that, despite the third-round dedication, a solution for the Irish border has not been found; neither EU citizens assured, nor an exit bill indicated.

Altogether, this suggests that Brexit uncertainty in particular has not been reduced. Therefore, a central mechanism behind Sterling’s long-term devaluation has not been addressed. Sterling’s gains may therefore not survive the medium term due to the rhetorical, intangible and underminable nature of its short term gains.

Ultimately, we must therefore conclude that for the risk averse individual, hedging may be a highly beneficial tool. With central bankers speaking in their droves this week, their individual positions should be elucidated, awarding limited predictability to sterling currency pairs. Nevertheless, the fragility of Sterling’s gains in non-normal monetary policy times should not be underestimated. Corporate requirements for hedging may include a protection of the Sterling costs of an international payroll, a reduction of importation expenses and value protection. Contact us to arrange any of these services.