Categories
Banks, Lenders & Investors Finance

The unpredictable relationship between currency values and stock markets – August Key Indicator

Too often the assumption is made that when a country’s currency value drops its stock markets will rise as its exports become more competitive.
The current economic situation in the UK and elsewhere is an illustration of why this may be an over-simplistic assumption.
Last week ended with £Sterling at its lowest value against the US dollar for two years at $1.2162 and against the Euro at €1.0948 while at the same time the FTSE100 closed down minus 2.34% at 7407.06.
This suggests that the previous so-called assumptions are no longer valid.
In commenting on this it should be noted that the European, US, Japanese and Hong Kong stock markets also plunged.

What is causing currency values and stock market  turbulence?

The signs that both the global and UK economies are volatile and have been for some time. Evidence for this can be deduced from the monetary stimulus by Central Banks.
In May the OECD (Organisation for Economic Co-operation and Development) revised its growth forecast for the UK to 1.2% this year and 1% next year in the light of ongoing uncertainty about the future of the economy.
In June the WTO (World Trade Organisation warned that 20 new trade barriers imposed by G20 economies between mid-October and mid-May, threaten to increase uncertainty, lower investment and weaken trade growth.
By July, Moody’s, the credit rating agency, and Mark Carney, BoE (Bank of England) Governor were both warning that a new cold war in trade would have a deep effect on the world economy.
Moody’s was also predicting a recession in the UK if it crashed out of the EU without a deal in October. It followed up later in the month that this was now more likely following the outcome of the Conservative leadership contest, which resulted in a new Prime Minister, Boris Johnson.
So, what actually influences currency values? The BBC has a helpful guide to the factors that can play a part:
* Economy: Strong economies have strong currencies because other countries want to invest there;
* Savings: When UK banks raise interest rates, holding savings or investments in pounds becomes more attractive;
* Prices: If UK goods are cheaper than those abroad, they will be attractive to foreign customers who buy Sterling to purchase them. This in turn increases the exchange rate;
* Public finances: The state of a government’s bank balance, or how much debt it has, can also affect the exchange rate;
* Speculation: The exchange rate is highly vulnerable to currency speculators, who buy and sell Sterling or who bet on currency movements based on their view of future events.
And how does currency value influence stock markets? A 2017 article in City AM argued that the strength of a country’s currency can have a surprisingly large bearing.
It argued that after President Trump was elected in the US, the S&P 500, the benchmark US share index, rose 10% to new all-time highs in the month following and cited the US dollar, which gained 3% during the same period as a key driver.
By comparison, after the 2016 Brexit referendum in the UK Sterling tumbled while the FTSE 100 rose sharply. In the three months following Brexit, the index rose 10.4%, largely, it argued, because the majority of FTSE 100 companies receive their revenues in foreign currency.
So what is different now to have caused both Sterling and the FTSE 100 to drop simultaneously? Arguably against a backdrop of slowing global trade and Brexit uncertainty a significant impact has been the ongoing trade war between the US and China.
The latest move has been a decision by Donald Trump to impose new tariffs on a further $300bn of Chinese imports in addition to those already in place.
Clearly, in such a volatile situation all the old “assumptions” about currency values and market behaviour are called into question and businesses and investors may need to review the basis on which they make decisions!

Categories
Banks, Lenders & Investors Cash Flow & Forecasting Finance General Turnaround

January Key Indicator – exchange rates and their impact on SMEs

exchange rates are no longer measured by goldThe exchange rate is the value of a country’s currency against those of others and the factors affecting this are many, especially in a volatile political climate, both globally and locally.
Among the influences are the interest rates set by central banks, inflation, a nation’s gross domestic product and trade balance, its debt and to a significant extent, the behaviour of politicians and governments towards both their own and competing economies.
Significant fluctuations in exchange rates, as has been seen over the last couple of years, then start to affect the confidence of investors, currency traders and businesses, increasing the volatility of currency values and stock exchanges.
Two obvious examples have been the plummeting value of £Sterling since June 2016, when the UK voted to leave the EU, despite occasional upticks as the negotiations over the withdrawal agreement dragged on.
Similarly, the engagement of the US President, Donald Trump, in imposing tariffs and instigating trade wars with other competing economies, particularly China, has arguably had a negative impact on both the value of the US Dollar and the performance of its own stock market.
Economic recovery, particularly in the UK and USA, has, in any case been sluggish in the decade since the 2008 global economic meltdown, which prompted central banks to set interest at very low rates in an attempt to protect their countries’ economies by stimulating investment and business activity.

A little history on exchange rates and currency values

Until the early 1930s, countries’ currencies were valued against the value of gold – the gold standard.
The quantity of gold held by a country determined the value of its currency and under the gold standard trade between countries was settled using physical gold. So, nations with trade surpluses accumulated gold as payment for their exports. Conversely, nations with trade deficits saw their gold reserves decline, as gold flowed out of those nations as payment for their imports.
The UK abandoned the gold standard in 1931 and the US in 1933, moving instead to the current fiat system, where currency values fluctuate dynamically against other currencies on the foreign-exchange markets. Fiat money is the currency that a government has declared to be legal tender, setting it as the standard for debt repayment. Essentially its value is based on market perception.
It has been argued that moving off an actual physical commodity like gold has made currency values and therefore exchange rates more vulnerable to manipulation by politicians and central banks, and therefore created a more volatile and vulnerable economic climate. This is where the market’s interpretation of politicians and central bankers is fundamental to currency values.

The effect of exchange rates on business

It is not only exporting businesses that are affected by exchange rates and currency values.
A good recent example has been the benefits to some UK SMEs, particularly in the service and hospitality industries, which during the summer of 2018 experienced something of a boom in tourism from a combination of a long season of good weather and the decline in the value of £Sterling making it cheaper for foreign tourists to visit the UK.
On the other hand, even small local SMEs whose businesses depend on selling goods and services where parts, components, food ingredients or raw materials come from overseas saw their costs rising because £Sterling’s buying power had been reduced in comparison with currencies in other countries.

Can SMEs protect their businesses from exchange rate fluctuations?

It can be harder for SMEs to protect themselves than it is for larger businesses, but the essentials for any business survival and growth are based on managing their costs and expenditure with strict and careful attention to cash flow which is best achieved by close scrutiny of monthly, or more frequent, management accounts.
If it is at all possible to manage cash flow in a way that a business can create a contingency reserve this will provide some measure of protection to a downturn in the exchange rate.
For those that have to source supplies from overseas, hedging against cost increases due to exchange rates can be done by negotiating a forward contract in your own currency based on a set price with the supplier or at least fixing the price with purchase of a forward exchange rate. This may mean missing out on future changes in the exchange rate that might benefit the SME buyer, but will provide some degree of certainty when planning ahead.
Another option may be to include clauses in your contracts which allow you to renegotiate prices should the exchange rate change significantly within an agreed period of time.
Wherever possible try to avoid the transaction fees charged by banks for making international payments. Some money transfer specialists offer an alternative, FCA regulated, service in a free multi-currency account that lets businesses hold over 40 currencies, and switch between them using the mid-market exchange rates to make payments.
While the risks of fluctuating exchange rates can be greater for SMEs with fewer reserves to fall back on planning and good communication can help to mitigate at least some of the risks.

Categories
Accounting & Bookkeeping Banks, Lenders & Investors Cash Flow & Forecasting Finance Turnaround

Choosing to do business in $dollars, instead of £Sterling

currency exchange boardWhile there is uncertainty and volatility in currency exchange rates, as has been the case since June 2016 and the EU Referendum outcome, many UK businesses might find it more attractive to trade in another currency, especially if they are purchasing goods in another currency.
Since June the value of £Sterling has plummeted by some 15% against the $Dollar and around 12% against the €Euro, making imports, such as raw materials, goods and supplies to the UK more expensive, although it has been positive for those UK companies that trade overseas.
This month the US Federal Reserve increased interest rates by 0.25%, suggesting that there is more confidence in the US economy and in the strength of the $Dollar.

The business advantages of using another currency

It is plainly of no benefit to a UK business operating only in the UK to switch all its transactions to another currency, but the situation is different for exporters and those who pay for purchases in another currency.
For these businesses the decision to switch, most likely to $Dollars, is about taking a longer term view of risk and currency values.
Many businesses work in other currencies and the $Dollar is for many industries the standard currency, as well as the one used when doing business in the Far East.
Opting for trading in $Dollars is changing the way you think about your business, in particular about paying bills, where it might be advantageous to have a $Dollar currency account.
One question to ask is what currency is more suitable given that UK interest rates are driven by the desire to protect employment.  Are US interest rates more stable that the UK?  If the UK is keeping interest rates low to promote employment, on one level that is a measure of instability.
Interest rates have been held down for far longer than they should have been since the 2008 Financial crisis and we would go for trading in $Dollars rather than any other currency.  It is all about managing risk.
But there is a note of caution. The cost of commercial insurance policies for those using $Dollars tends to be much more expensive due to the assumption that a business is more likely to be exposed to US law and the prospect of litigation.
If you got this far, I thank you for reading my blogs and wish you a very happy New Year.

Categories
Banks, Lenders & Investors Cash Flow & Forecasting Finance General Insolvency Turnaround

Who are the winners from post EU Referendum £Sterling drop?

currency exchange boardWhile the future of UK business remains uncertain following June’s EU referendum the resulting plunge in the value of £Sterling is already showing dividends for some.
Among K2’s clients is a metal fabricator, which has been very busy supplying clients in both the UK and in Europe with specialised products from its factory. Fortunately, they have benefited from holding a large stock of steel bought pre-referendum.
In the UK, there are signs also that businesses selling high end goods have been benefiting from the increasing numbers of overseas tourists who have been taking advantage of the favourable exchange rate to indulge in some retail therapy. Equally, the car dealerships appear to have been holding up well despite the uncertainty.
The lower value of £Sterling clearly benefits companies selling not only into Europe but also exporting elsewhere as well as those businesses, such as retail and tourism, who are attracting overseas visitors.

… and the losers?

Some businesses, however, are already having to increase their prices because they need to buy parts or raw materials from abroad.
We know of one small specialist in repairing Apple computer hardware who has had to raise prices because of an increase in the cost of buying certified Apple replacement parts.
In addition to the devaluation of £Sterling on the currency markets, which clearly benefits exporters, there are also signs that commodity prices have started to stabilise and are coming out of their long recent slump, so, for example, fuel prices have started to increase at UK petrol pumps, perhaps helped by the recent OPEC decision to limit oil production and exports. Indeed, the impact of exchange rates and increase in the $USD cost of fuel will be painful for many where reports are of a likely 50% increase in £Sterling price of fuel.
This is likely to put added pressure on costs for any UK business that needs to use vehicles, whether it is for deliveries or for transport to on-site working as is the case for many small suppliers of domestic services such as electricians, plumbers, gas engineers and the like.
The increase has also shown in the latest Consumer Price Index (CPI) rise in inflation, published by the Office for National Statistics (ONS). It revealed that inflation had risen to 1% between September 2015 and 2016, the highest 12-month rate since November 2014. The ONS cited increased fuel, hotel and restaurant prices as the main influences.