Currency Challenges Fuelling More Fears for 2022

By Raymond Parkes, freelance writer.

From 2020 to 2022, disruptions in global supply chains wreaked havoc on the global economy. Heading into the tail end of 2022, we’re beginning to see the other side of that coin, where the economy is now taking its toll on the logistics industry.

There are still fears about global supply, namely energy and the HGV driver shortage. But no longer is the microchip shortage, or even the driver shortage, the dominant discourse - things are now much worse. Inflation, debasing currencies, and an upcoming recession are now front page.

Inevitably, manufacturing and logistics use a lot of energy to create and transport goods, which is becoming increasingly expensive. June 2020 showed the slowest growth in US factory activity since July 2020, whilst freight rates rise and logistics are the ones to bear the greatest increase in costs.

Another huge concern for European logistic companies is the depreciation of the Euro and Pound. The Pound and Euro are both experiencing a depreciation, making it more expensive to import goods and services from outside the continent. With Russia’s energy supply tightening up, monthly oil shipments from the US have climbed to their highest since 2016. With a strong Dollar and weak Euro, this is even more costly. So, why is the USD strong anyway, and what is the impact of strong USD on imports?

Why is the USD strong?

There are two sides to this equation. Whilst it is a matter of the strong dollar, it’s equally as much about the Euro and Pound weakening.

There are two main reasons for the USD’s recent rise in demand. Firstly, the Federal Reserve has continuously increased interest rates. As interest gets higher, savings become more appealing, and internationals look to buy US bonds and store their money as USD.

The second reason is that the USD is the global reserve currency. By definition, it’s the safest currency in the world. Whilst many fringe analysts enjoy speculating on the future crisis of the USD and why they need to bring back the gold standard, in reality, it is a currency that is used by countries around the world. In times of crisis, it becomes a safe haven, particularly compared to the Euro, which is looking like an unstable currency - which brings us to why the demand for the Euro and Pound are out of favour.

For the Euro, it’s in part because the ECB currently has a negative interest rate - it costs money to hold the Euro. But, underneath why this is, is even more concerning. It’s clear that rates should have increased a long time ago, but many of the weaker member economies would struggle to repay debt. This disparity between the strong and weak economies is currently shining a light on the challenges (and speculated potential failures) of a single currency. Any existential threat to the idea of a Eurozone is going to debase the currency.

As for the UK, they too have failed to keep up with the Fed’s continuous rising of interest, making it comparatively less appealing to hold GBP. Beyond this, unemployment is on the rise and because of the fallout from Brexit, it seems like the UK could be hit particularly hard in the event of a recession. Plus, there is speculation around a new Scottish independence referendum.

With all things considered above, and the fact that the US is more energy independent and doesn’t have a Russo-war on its doorstep, the USD has become highly favoured.

How businesses will respond to this

One good thing is the impact of a strong dollar on exports - European products are becoming more affordable, so they may see a rise in demand (though, not if they don’t see recession-proof goods). However, paying overseas suppliers and such has become comparatively more expensive.

One way businesses may combat this is to simply hold off on USD payments where possible. When the opportunity presents itself, payments could be timed during temporary changes in FX spot rates. So, days payable outstanding could increase.

However, this could be a devastating strategy. Even though it will inevitably be tried among many companies, it has an underlying assumption that the current strong USD is temporary.

Waiting to catch dips that never come could see companies get even further into trouble. There’s no reason to believe the USD won’t continue to appreciate, particularly given the forecasts that Europe could be hit hard by recession.

How to offset currency risk

Although difficult to admit, the truth is that we have no real idea around whether the USD will appreciate further or depreciate. We can’t even side with one view more than the other - we must remain perfectly neutral to these beliefs.

The reason for this is related to the Wisdom Of The Crowds - that the mean guess of all market participants is almost certainly better than any one individual's guess, even if they’re an expert. Also, they’re forward-looking, so anticipated future economic factors are already factored into the currency prices. Businesses cannot gain any speculative advantage here; they can only gamble.

So, to catch the best rate is to do two things: use a good broker and take the best exchange rates offered today - waiting will only incur currency risk. The first is easy, as it means shopping around for the best USD rates. The best currency rates are usually provided by FX specialists that focus on business solutions and provide free quotes.

The second way, though, is a harder pill to swallow. In order to leverage the idea of taking today’s rate further is to make use of hedging products. A Forward contract can help ensure that a business's future USD transfers are using a pre-agreed price. So, next month’s payment to suppliers can be guaranteed with a USD price similar to today’s.

Gaining this protection from currency risk is important. Whilst businesses don’t know what the price will be in the future, they can guarantee one thing with a Forward: it won’t be worse than today.

This doesn’t just protect from further USD appreciation, but it creates certainty. Certainty around cash flow is important for investors and stakeholders. It can mean more accurate forecasts and staying solvent during what will inevitably be a tough recession.