In this edition of Global Focus by Wells Fargo
- World headlines: Dave Napalo
- Ask the expert: SEPA simplified: How U.S. companies doing business in Europe can benefit
- In the spotlight: Managing currency exposure to China
- People power: Mark Beck, Global Banking relationship manager for Western Canada
- News and events: News in brief
Dave Napalo, Head of FX Risk Management for Wells FargoJust under ten years ago, Thomas Friedman published his seminal work, "The World is Flat." Since then, that phrase has become synonymous with the inter-connectedness of the global economy. Recent economic events have demonstrated just how true that is. Read more
Just under ten years ago, Thomas Friedman published his seminal work, "The World is Flat." Since then, that phrase has become synonymous with the inter-connectedness of the global economy. Recent economic events have demonstrated just how true that is. In 2013, when the Fed signaled its intention to begin reducing its policy of quantitative easing, several emerging market currencies experienced sharp depreciations as global markets responded with a generalized "risk off" reaction. With the prospect of an easy money policy from the United States gradually evaporating, global assets were due for a reassessment of their value. To a large degree, U.S. interest rate policy and its impact on the world at large has been the continuing theme of 2014, as the first quarter was dominated by new developments in the emerging market countries.
By and large, the economic performance of the U.S. and the rest of the G7 world might be characterized as middling throughout the first quarter of 2014. To be sure, unusually poor weather conditions weighed heavily on the U.S. economy. Extreme cold temperatures and a series of snow storms cut into consumer spending, home sales, construction, and industrial activity. By the quarter end, there were some encouraging signs that helped moderate disappointing results earlier in the quarter. February retail sales posted a 0.3% gain, reversing two consecutive months of declines. Industrial production bounced back by a sizable 0.6% in February after posting a 0.2% decline in January. As March came to a close, stronger consumer spending on services led the third estimate of fourth-quarter GDP higher to a 2.6% annualized rate, the fastest since the start of 2012. Finally, job creation improved in March as the economy added 192,000 new jobs during the month while the unemployment rate held steady at 6.7%.
The quarter also saw Janet Yellen become the 15th chair of the Federal Reserve. Her first press conference proved a challenge as she was faced with explaining her committee's decision to continue cutting back the Fed's quantitative easing (QE) while recent economic indicators had proved disappointingly soft. Purchases of securities by the Fed are to slow by another $10 billion to $55 billion per month starting in April, suggesting that QE as a whole might cease as early as October of this year. CPI, rising at an annual rate of 1.1%, remains well below the Fed's target of 2.0 %. Similarly, wages are hardly running out of control, growing at an annual rate of 2.0% in most recent estimates. Further, housing starts have disappointed, as February's activity declined another 0.2% after a disastrous 11.2% pullback in January.
At a subsequent speech in Chicago, Ms. Yellen further attempted to walk a fine line between tightening monetary conditions while still providing stimulus to the economy. Citing that there was still considerable slack in the economy and the labor market, Yellen dropped the previous promise to hold Federal funds rates below 0.25% at least until unemployment is below 6.5%. As that threshold is rapidly approaching, Yellen indicated that future rate rises will be assessed using a range of economic data with no single target paramount. This soft guidance buys time and flexibility, but other members of the Fed's rate-setting committee continue to build a more hawkish position, suggesting that a rate rise could come as soon as mid-2015. This hint of the end of easy money in the U.S. has had a rippling effect throughout the global market, but particularly in the emerging market sector.
The emerging market sector
There is an old saw in the markets that says when the tide goes out, you discover who is swimming without a swimsuit. Such has been the case for many countries whose economies are considered to be emerging markets. Following the financial crisis of 2008 to 2009, emerging economies were a growth engine helping to facilitate a global economic recovery. However, in the past couple of years, the economic fundamentals of the developing world have begun to deteriorate. Excluding the performance of China and the oil-exporting countries of the Middle East and North Africa, the aggregate current account position of this group of nations has swung into a deficit position. Rates of economic growth have slowed from their earlier robust pace, and inflation rates have been on the rise. This is a formula that could have drastic impacts on these developing economies, and the pressures on developing economies manifested themselves in waves throughout the first quarter of 2014.
The first wobble in the emerging market space afflicted Turkey. Worries in Turkey began when prosecutors launched a series of investigations into bribery and corruption close to the government of Prime Minister Erdogan. In addition, with inflation running over 7% and a current account deficit of 7% of GDP, the markets also quickly focused on the deteriorating economic situation. As the Turkish lira came under sudden pressure, monetary authorities resisted adjusting policy in defense of the currency. That stance proved temporary, when in an emergency meeting the central bank increased overnight lending rate from 3.5% to 8%, as well as the one-week repo rate from 4.5% to 10%. After hitting a record low of 2.3365 in late January, the lira to the dollar rate has settled back to the 2.13 level, approximately where it had traded before the crisis began. Still, the lira is a long way from the strong 1.80 level that it enjoyed when times were more flush with capital inflows.
The next unfortunate market victim to earn the spotlight was Argentina. Labor discontent with low salaries and the inadequacy of public services, highlighted by a power failure during a heat wave in Buenos Aires, raised concern over the precariousness of the country's economic and political position. As foreign currency reserves fell to a seven-year low, the central bank stepped away from intervention, leading to a rapid depreciation of the currency in the neighborhood or 14%. Since late January, the peso has stabilized around 8.00 to the dollar, but private analysts have stated that it is not unreasonable for the exchange rate of the peso to fall to 14.00 per dollar.
Misery loves company, and in the Americas, Argentina can look at Venezuela for comfort. Venezuela is in desperate straits. Inflation is running at 56% and the black market for dollars trades at seven times the official rate for the bolivar. Venezuela is running out of money to pay its bills, and its arrears on non-financial debt are leading to a raft of shortages in basic goods. In the absence of the government improving its international relations and becoming friendlier to inflows of foreign capital, the country seems certain to slide further towards economic chaos.
India, Brazil, and South Africa are three additional countries that have had to be vigilant to stem additional pressure on their currencies. The central banks of all three countries raised short term rates in Q1 — India from 7.75% to 8%, Brazil from 10% to 10.75%, and South Africa from 5% to 5.5%. While the currencies of all these countries experienced some pressure during the quarter, active monetary authorities pre-empted a crisis atmosphere from developing.
Finally, China, as the world's second largest economy, had an impact on the global currency relationships throughout the quarter. While China's economy is still growing at a relatively rapid pace (7.7% year-on-year real GDP in December 2013), a fall in December's industrial production suggested a slackening of growth. Clearly, China's reduced demand for commodities contributed to the deteriorating current accounts of developing countries and sets the stage for further concern about the pace of the global economic recovery.
But China factored importantly in another way during the beginning of 2014. After a long period during which the yuan was allowed to appreciate gradually against the dollar in a narrow band, Chinese authorities threw a curve ball by allowing the currency to weaken, losing about 1% of its value in the space of a few days. In late February, Chinese foreign exchange regulators advised the markets that reforms would lead to two-way fluctuations in the currency becoming the normal state of the market.
China had two reasons for implementing this change. The first was an effort to discourage the yuan from being a candidate for the so-called "carry trade." In the last quarter of 2013, a net $22 billion of "hot money" flowed into China, as speculators borrowed cheaply in dollars and lent in yuan, skirting China's capital controls and benefiting from both China's higher interest rates as well as the yuan's appreciation. Pulling the rug out from under the speculators is an effort to eliminate the perception that yuan appreciation is a one-way street.
Secondly, as currencies of other emerging countries were depreciating against the dollar, the yuan had risen by 2.8% in the year to January. The resulting loss of competitiveness supported efforts to weaken the yuan and bring up short the speculative pressure on the currency. At the same time, authorities issued forward guidance that the central bank would enlarge the yuan's trading band later this year. While it seems certain that over the long term the yuan will ultimately rise, in the short term, the recent changes give the Chinese authorities more room to maneuver in pursuit of their domestic and international policy objectives.
Ask the expert
SEPA simplified: How U.S. companies doing business in Europe can benefitPhil Ward, a product manager for the Wells Fargo International Group, offers his insights. Read more
For U.S. companies on the outside looking in, the Single Euro Payments Area (SEPA) can seem to be a daunting mix of regulation and the unfamiliar. However, for companies with euro transaction flows, there can be considerable rewards and cost savings, and with the right banking partner, getting the most out of SEPA should not be complicated.
What is SEPA?
SEPA is an initiative launched by the European banking and payments industry with the goal of ensuring quick and efficient money movement within Europe. Within SEPA there is no distinction between a national payment and a cross-border payment; both are processed the same way and at the same cost.
In order to achieve this new borderless payments landscape across the 34 SEPA countries, two new payment methods were introduced: SEPA credit transfer and SEPA direct debit. The credit transfer is comparable to an ACH credit in the U.S. and is a "push" payment, with the originating party sending the funds to the beneficiary. SEPA direct debit is comparable to an ACH debit in the U.S. and involves the originating party "pulling" the funds back from a third party account.
SEPA end date
European regulation mandates that the legacy national euro ACH clearing systems must close by August 1, 2014. The original date was February 1, 2014 but a 6-month grace period was granted to allow extra time for companies to transition existing payment flows to SEPA.
As of this date, all euro ACH payments will need to be sent via SEPA. When using SEPA, both the sending and receiving accounts must be located in a SEPA country. This means that U.S.-based companies will no longer be able to send euro ACH payments from U.S.-based accounts. In order to make payments to Europe, they will need to use other more expensive payment methods or open an account in Europe to use SEPA.
How could SEPA benefit you?
Some of the key benefits of SEPA are:
- Cost reduction through the use of ACH rather than wires or foreign drafts.
- Reduced banking fees through consolidation of accounts. Within SEPA there is no longer any need to hold accounts in multiple countries across Europe. All payment processing can be done from a single account, as long as it is located within a SEPA country.
- Pan-European reach with payments available to and from any of the 34 countries that are part of SEPA.
- Fast next-day settlement and elimination of lifting fees, so the beneficiary receives the full amount of the transfer.
- Increased processing efficiency and simplicity through standardization. SEPA payments use the ISO 20022 XML standard, which means you do not have to deal with different formats for different countries.
- Flexible payment options. The ability to send a payment by either SEPA credit transfer or direct debit means you can choose the payment method that best suits both you and your European trading partners.
Opening a Wells Fargo London branch account gives you access to SEPA, allowing you to send and receive credit transfers as well as make payments by direct debit. We use our local experience to ensure that the account opening and onboarding process are simple and straightforward. Our London branch accounts are fully integrated in our online Commercial Electronic Office© portal, so you'll have greater visibility and control through the same familiar channels.
To find out more about how we can help you make SEPA simple, please contact your Wells Fargo representative or email our international customer service team at InternationalConnections@wellsfargo.com.
Phil Ward is a product manager for the Wells Fargo International Group. He is based in London and can be reached at email@example.com.
In the spotlight
Managing currency exposure in ChinaFrom the results of the recent Wells Fargo 2014 Foreign Exchange Risk Management Survey, it is apparent that business dealings in China are at the forefront of the minds of many corporate entities. Read more
From the results of the recent Wells Fargo 2014 Foreign Exchange Risk Management Survey, it is apparent that business dealings in China are at the forefront of the minds of many corporate entities. Six of every ten respondents to the survey have a subsidiary in China, and 14% of respondents ranked the Chinese currency, the yuan (CNY), as being among their top three currency concerns. In addition, 55% of respondents indicated that they purchase goods, materials, or services from China, whether denominated in U.S. dollars (USD) or the local currency. Most survey respondents were from the manufacturing industry (42%). This sector is followed by wholesale trade (16%) and technology (13%). The CNY has strengthened considerably in the recent past. CNY strength, in turn, has caused corporate managers to ask: If the CNY were to strengthen further against the USD, would we still be acceptably profitable?
Against this backdrop, we have observed many of our customers becoming more active managing their exposure to a strengthening CNY. A first step in this process is to recognize the exposure, which may be less obvious than one might initially assume. Take for example the company that pays its Chinese vendors in USD. This company may be under the impression that since the payments are denominated in its functional currency that currency risk does not exist. Because these USD amounts have been rising as a result of CNY currency appreciation, the exposure to currency persists irrespective of denomination. To illustrate the point further, as CNY has appreciated steadily at a rate of 2-3% each year, this simply means that the value and purchasing power of a dollar has also fallen 2-3% each year. In all likelihood, this can cause vendors to raise prices 2-3% each year to compensate for the less valuable USD. Many of our customers find themselves in this position, as 75% reported settling payments to China in USD. Even without direct exposure to CNY, companies can still use hedging instruments to protect against this economic exposure.
For a company that settles in USD but is still exposed to currency risk as detailed above, an appropriate hedging solution to neutralize currency fluctuations might be to provide a USD payment to offset rising USD costs related to CNY strength. The hedge would essentially reimburse the company, in USD, for CNY strength (and vice versa), thereby locking in its net USD cost of Chinese expenses over the life of the hedge. Forward contracts can be set up to achieve the desired result, and many of our customers have used this risk management technique. The hedge establishes for the customer a specific USD cost of a predetermined amount of CNY, which is "net settled" at each settlement date. If the underlying USD cost of the needed CNY were to rise, then the company would receive a payment from the hedge (and vice versa) to bring it back to the same net USD cost.
Once the strategic decision to hedge is made, the company needs to tactically decide the hedge amounts and tenors. There are several key considerations for determining the hedge amount and the length of the contract. These include: 1) the degree of confidence in forecasted business results, 2) the ability to pass on cost increases to customers, and 3) the desire for an improved hedge rate, which in the case of the CNY improves as the tenor of the hedge increases.
For many of our customers, doing business in China is an integral part of their business models. Whether a company-owned factory or long-established vendor relationship, the exposure can in many cases be considered long-term and arguably requires a long-term solution. In these cases, customers with a predictable and sustainable exposure to China might consider the long term and seek to hedge forecasted transactions out several years. A key motivating factor is the estimation of a company's ability to pass on cost increases; a company is highly unlikely to be able to pass on immediate foreign exchange rate volatility to its customers, but may be able to do so over a multi-year time horizon. Of course, if the company has a long-term hedge in place, there is enough time to push a price increase through to compensate for the cost increase before feeling margin compression.
Finally, the CNY may be attractive to long-term expense hedgers as hedge rates further in the future are often more advantageous to the customer (each USD buys more CNY). Combining these three related considerations translates into hedging a conservative amount of forecasted cash flows for a sustained period of time, providing the company with greater comfort that it will not be over-hedged but still providing the offset necessary to manage the business effectively.
It's important to assess the effects of the possible erosion of USD purchasing power versus the CNY and also to consider that this particular risk can be effectively managed and mitigated. Essentially, it all boils down to the question asked earlier in the article, "If the CNY were to strengthen further against the USD, would we still be acceptably profitable?" If the answer is negative or unclear, the next step is to determine what can be done to manage the risk exposure to a level that makes a company comfortable with its long-term competitive position.
Jeff Uken is a derivatives sales representative for Wells Fargo Foreign Exchange Risk Management. He is based in San Francisco and can be reached at firstname.lastname@example.org.
The information and opinions in the survey referred to above may not be appropriate for, or applicable to, some or any of your activities or circumstances. Wells Fargo makes no representation or guarantees with respect to any of the information or opinions in the survey and assumes no liability for any such information or opinions. The information and opinions may not be representative of all Wells Fargo clients. In providing the information and opinions in the survey, Wells Fargo is not giving you any financial, tax, accounting, legal or regulatory advice or recommendations. Before using or acting on such information or opinions, you should seek advice from your own independent advisors and conduct a thorough and independent review of any transaction or strategy in light of your particular circumstances.
Introducing Mark Beck, Global Banking relationship manager for Western CanadaWhile Mark was born and raised on the prairies of Edmonton, Alberta, his home is now the beautiful west coast of British Columbia in Vancouver. Read more
While Mark was born and raised on the prairies of Edmonton, Alberta, his home is now the beautiful west coast of British Columbia in Vancouver. His education and profession have taken him far afield to Calgary, London (Ontario), and Toronto, with work across the U.S. and parts of Asia (Hong Kong, Singapore) and Eastern Europe (Minsk, Kiev).
With 18 years of banking experience, Mark joined Wells Fargo at the beginning of 2013 as a relationship manager providing Canadian corporate multinationals and the subsidiaries of U.S. companies with a full range of international and commercial services including credit, treasury, foreign exchange, and trade services. Mark took on the challenge of being one of the two original Global Banking team members in Canada, and has "enjoyed the opportunity to build up our capabilities and the exposure of Global Banking with other Canadian-based team members and Wells Fargo as a whole." Mark sees tremendous opportunities for growth in Canada for the bank. "Wells Fargo has a great reputation in Canada and our seamless approach to cross-border banking is resonating well with companies that do business in the U.S.," he says.
Prior to joining Wells Fargo, Mark held positions at various Canadian banks where he worked primarily in corporate banking and syndications as well as corporate finance, leveraged finance, and as a regional head of trade finance.
Passionate about juvenile diabetes research, Mark recently organized a Wells Fargo team to participate in the Ride for Diabetes event in Vancouver. With all proceeds going to the Juvenile Diabetes Research Fund, Mark and the team raised funds for this worthy cause and had some fun while they were at it. "To foster some healthy competition, we split into two teams to see which team could ride the furthest on a stationary bike in eight minutes!" Mark shared. "To help spur both teams on we were joined by my daughter Chloe who has Type 1 diabetes."
Outside of work, Mark spends most of his time running his three children around to their various activities and spending as much time as he can with his wife and kids in the great outdoors. "One of the best things about living in Vancouver is the multitude of activities afforded by our physical surroundings and moderate climate. Sometimes we can be on a snowy mountainside and a very short while later be on the beach or sailing on the ocean in shorts and t-shirts!"
If Mark does find a spare moment to himself, you can find him hiking, skiing, or playing golf, a sport he used to play competitively. In addition, Mark recently ran in the Vancouver marathon. "It was very hard for sure, but there's something about the marathon that makes you want to do more. Hopefully I've got a couple more in me!" Mark laughs.
Mark has always thought that the golden rule and walking a mile in another's shoes are great philosophies to live by. "I'm amazed at how effective and powerful teams and organizations can be when teammates make the effort to truly understand each other's views and opinions. I know for sure that Global Banking as a whole has a fantastic opportunity to be a key driver for stretching Wells Fargo's growth into new and exciting regions, all the while supporting and enriching the U.S. platforms."
News and events
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The views expressed are intended for Wells Fargo customers only. They present the opinions of the authors on prospective trends and related matters in foreign exchange markets and global markets as of this date, and do not necessarily reflect the views of Wells Fargo & Co., its affiliates and subsidiaries. Opinions expressed are based on diverse sources that we believe to be reliable, though the information is not guaranteed and is subject to change without notice. This is not an offer to sell or the solicitation to buy or sell any security or foreign exchange.