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Dave Napalo, Head of FX Risk Management for Wells FargoThroughout the second quarter of 2014, financial commentaries often resorted to the word "benign" to describe global economic conditions. lists the pathological definition of the word — "not malignant, self-limiting" — last among its list of definitions. The others refer to rather more healthful or salubrious qualities: gracious, gentle, kind, and favorable. With the calamity of the financial crisis not yet fully purged from memory, the relative calm of the second quarter economic activity does lend itself to the benign adjective. Read more

Photo of Dave Napalo

Throughout the second quarter of 2014, financial commentaries often resorted to the word "benign" to describe global economic conditions. lists the pathological definition of the word — "not malignant, self-limiting" — last among its list of definitions. The others refer to rather more healthful or salubrious qualities: gracious, gentle, kind, and favorable. With the calamity of the financial crisis not yet fully purged from memory, the relative calm of the second quarter economic activity does lend itself to the benign adjective. Nonetheless, there was a certain unease that permeated the financial markets in April, May, and June. By and large, the emerging market currencies displayed relatively stable performance, particularly when compared to the fireworks of the first quarter of 2014. Thus, the latent worries gravitated to the developed economies, with the United States, the Eurozone, and the United Kingdom each manifesting their own versions of nervous markets.

The United States

The U.S. economy emerged from the first quarter of the year beset by numerous weak signals as one of the worst winters on record wreaked havoc with economic activity throughout the country. Indeed, the preliminary release of second quarter GDP was wildly over-optimistic at a reported rise of 0.1% at the end of April. The first revision at the end of May reported that GDP had actually fallen at a rate of 1.0%. This release was then trumped by the final revision on June 25, when the Commerce Department announced that the decline was actually 2.9% at an annual rate. The third estimate of first quarter GDP resulted in the largest quarterly contraction since Q1 2009. Total consumer spending was a particular disappointment, expanding at only a 1.0% annual rate, substantially lower than the previously reported 3.1% estimate.

Along with the use of the word "benign," a second market mantra for the quarter can be attributed to Federal Reserve Chair Janet Yellen, "A high degree of monetary accommodation remains warranted..." While that phrase, or words to that effect, can be traced to Yellen's predecessor, Ben Bernanke, it was the centerpiece of her testimony prepared for delivery to the Joint Economic Committee of Congress on May 7. In support of that position, she cited the improving but persistent level of high unemployment and the inflation rate remaining below the Fed's target of 2.0%. A final look at inflation during the quarter did not shake the Fed's overall outlook. On June 17, the headline Consumer Price Index increased 0.4% in May, recording a stronger monthly gain for the third straight month. Year-over-year, headline CPI was up at a solid 2.1% pace. Yellen brushed aside for now concerns about quickening inflation, emphasizing the Federal Open Market Committee's (FOMC) view that rates are likely to stay low "for a considerable time."

The FOMC trimmed its bond-buying once again. This is the fifth straight meeting with a $10 billion reduction, keeping the FOMC on pace to end the program later this year. This steady-as-she-goes approach has translated into an ongoing rally in the treasury markets, and by extension, the corporate fixed income market, where issuance of debt securities continues at robust levels. The fixed income market continues to confound would-be bears that have had to cope with a ten-year treasury yield of just over 2.5% — a full half percentage point lower than it was at the end of 2013. Moreover, there are nascent rumblings about the possibility of another bubble emerging in the equity markets. The Fed has ample reason, however, not to rock the boat. The start of its tapering program a year ago sent long-term interest rates up sharply, nearly derailing the housing market recovery. Contributing to an unwarranted inflation scare could once again send rates higher and undermine the U.S. economic performance just as it appears to be emerging from the temporary setback of the first quarter.

The overwhelming majority of Fed decision-makers continue to believe the appropriate time to begin hiking the federal funds rate is sometime in 2015. Many Fed presidents have also noted that the economy appears to be ahead of schedule, suggesting that the first rate hike could come earlier and that rates may rise a little faster than previously thought. This view was given further weight with the release of an encouraging June jobs report, which indicated that 288,000 jobs were added to the economy and the unemployment rate falling to 6.1%. It is within the framework of this U.S. interest rate landscape that we assess the economy of the Eurozone countries and base our outlook for the dollar's future performance against the euro.

The Eurozone

For many years, Japan has been the principal example of a toxic mix of unfavorable demography and a legacy of a debt crisis leading to a long period of sluggish economic growth and low inflation, or possibly even deflation. Within recent months, however, that description has spread more and more frequently to the countries comprising the Eurozone. Stagnation is becoming more entrenched in several big European countries, notably France and Italy. With Eurozone CPI barely positive at 0.5% in the year to May, the European Central Bank (ECB) at its June meeting took unprecedented steps to forestall the march towards possible deflation. Among the elements of the package of comprehensive measures to add liquidity, the most notable was cutting its rate on overnight bank deposits by 10 basis points to -0.10%, making it the first major central bank to shift one of its main policy interest rates into negative territory.

Following the meeting, ECB President Draghi was quoted as saying, "If required, we will act swiftly with further monetary policy easing." The central bank's updated CPI inflation forecasts add further weight to the argument for easing. With inflation forecast at 0.7% in 2014, 1.1% in 2015, and 1.4% in 2016, CPI is likely to undershoot substantially the ECB's inflation target of 2.0%.

Notably, the ECB stopped short of implementing quantitative easing, an essential component of the Fed's program to keep interest rates low while stimulating the economy. However, the market was not expecting the ECB to move on that specific step, therefore the absence of any movement on that front did not come as a disappointment to market participants. In total, the ECB's comprehensive easing plan and its continued dovish tone stands in contrast to the Fed's shift to a less accommodative monetary policy, albeit a gradual and cautious withdrawal of support from the markets. Consequently, we maintain our outlook for a softer euro in the quarters ahead, targeting a EUR/USD exchange rate of $1.29 in 12 months' time.

The United Kingdom

Compared to the U.S. and the Eurozone, the economy of the United Kingdom (U.K.) is showing signs of flexing its muscles. Economic growth in the U.K. has maintained an impressive pace, even while the U.S. was experiencing its first quarter GDP wobbles. First quarter U.K. GDP came in at gains of 0.8% quarter-on-quarter and 3.1% year-over-year. This economic release was further supported by a strong rise in industrial production as well as a 1.1% increase in retail sales during the March through May period. The housing market in the country remains strong, even prompting concerns about another housing bubble in the overheated London market. Indeed, Wells Fargo's economists forecast U.K. GDP growth of 3% in 2014 and 2.7% in 2015 and expect British economic growth to outpace that of the U.S. economy during both of those years.

While the Bank of England (BOE) overall views that there is still sufficient slack in the economy for additional expansion to occur without precipitating a rise in inflation, early signs of vigilance have begun to appear. In an early June speech Mark Carney, the BOE's governor, stated that a decision to raise interest rates is becoming more balanced, and that it "could happen sooner than markets currently expect." Reinforced by hawkish comments from the Bank of England's monetary policy minutes, the market took the sentiments to heart, pricing an increase into interest rate futures to reflect a possible rate hike as early as next January. On cue, the pound traded above $1.70, reaching its highest level against the dollar since 2008.

U.K. inflation remains tame, with the May CPI slowing to just 1.5% year-on-year. At the margin, however, it appears that the BOE is managing with a more attentive eye on the strength of economic growth than concern about inflation. Taking into account developments in June, we have adjusted our outlook to include further moderate sterling strength against the dollar, now targeting a GBP/USD exchange rate of $1.7300 in a year's time. Similarly, with the divergent trends between the Eurozone and the U.K., the pound stands to gain appreciably against the EUR, with a target EUR/GBP exchange rate of GBP 0.7450 in 12 months' time.

In the coming months, we will be watching economic releases to see whether the expectations of "benign" conditions prove accurate for various global economies or a more serious prognosis lies ahead.

Ask the expert

Exposure identification: A critical step in understanding and managing currency riskRamon Espinosa, Managing Director, Head of Foreign Exchange Analytics, shares his insights. Read more

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Identifying exposure is a critical step in effectively managing currency risk. Having timely information about the sources of currency risk allows you to assess the materiality of those risks, identify and execute appropriate strategies to mitigate them, and implement appropriate policies and controls. Although good exposure information does not guarantee effective risk management of foreign exchange (FX), without it, effective risk management is not possible.

In the eight critical steps to effectively manage currency risk (see callout) identifying exposure follows defining your company's risk management philosophy and objectives. This order is logical because the definition of your company's risk management objectives should include identifying specific financial performance metrics that your stakeholders value most. These performance measures will guide the process of exposure identification. That said, identifying exposures can influence your company to modify its risk management objectives. Therefore, you do not need to complete the eight steps in strict order.

Eight steps to effectively manage currency risk

  1. Define overall corporate philosophy and objectives
  2. Identify exposures
  3. Quantify exposures
  4. Define risk management policies and procedures
  5. Identify strategies to manage risks
  6. Execute strategies
  7. Monitor exposures and hedges
  8. Review and measure performance

Risk inventory

Typically, the process of identifying exposure begins by completing a broad inventory of the channels through which currency fluctuations might affect your company's preferred financial performance measure(s). For example, if your company is most concerned with the effects of currency fluctuations on consolidated cash, the inventory would highlight all non-U.S. dollar cash balances as well as near-cash equivalents, such as liquid investments in marketable securities, as sources of risk.

If your company also is concerned with all potential sources of FX gains and losses, the risk inventory would grow to include nonfunctional currency-denominated monetary assets and liabilities, such as accounts receivable and payable, as sources of risk. This objective is a common practice for a variety of companies with multinational interests. According to Wells Fargo's 2014 Risk Management Practices Survey, a majority of participants and 62% of the public firms cited "eliminate FX gains/losses" as their most important risk management objective.

Finally, if your company is concerned with the exposure of net income to currency risk, the inventory would grow to identify and include projected non-U.S. dollar revenues and expenses from core operations. Because these exposures are projections of future activity, they inherently represent what is often termed "economic" risk to eventual FX movements. As such, companies must rely on forecasts to include this exposure in their inventory, and the accuracy of the forecasts becomes crucial. Despite the challenges that might result from forecasting errors, 59% of respondents to the survey reported hedging some portion of their forecasted FX transactions.

Accounting review

During the inventory phase, you should review the financial reporting of foreign currency transactions because accounting considerations will affect the range of information collected and the requirements of systems that may need to be developed. For example, the accounting review will likely highlight the importance of gathering and retaining information about transactions in the units of the currency in which they are denominated, rather than in their U.S. dollar equivalents only. Similarly, the accounting review will identify the importance of collecting a range of transaction-related information, such as the functional currencies of entities recording transactions, booking and settlement dates, and the methodologies used to set booking and income translation rates.

The inventory phase also should include a detailed review of business practices, such as your company's pricing policies, currencies in which transactions are priced, and frequency and nature of price adjustments. Inventory management should be considered, as these practices can result in or influence currency risks. This phase also should include an assessment of the timing and magnitudes of business flows, because they will influence the frequency with which information will need to be collected.

Finally, the inventory phase should include a survey of existing information systems and flows to identify gaps that will need to be filled. For example, if your company's risk management objective focuses around risks to future income, risk managers will need projections on future foreign currency transactions. If such projections are not available, the firm should institute a process to ensure the regular preparation of reliable forecasts. Assessing the availability of information and identifying gaps ensures that necessary systems are in place to minimize risk.


Once the inventory phase is completed, risk managers can move to the implementation phase of exposure identification — or the actual development of information systems to collect data. In this stage, some companies may find it useful to introduce systems developed by third parties; however, most firms rely on internally developed, spreadsheet-based systems. In either case, systems should provide good exposure visibility at a frequency appropriate to your company's sensitivity to foreign currency fluctuations.

In addition, systems and processes should be scalable and resilient, and capable of adapting to changes in your company's international profile, business practices, and even risk management objectives. The systems should be flexible, allowing consolidation and netting of exposures to address specific analytical needs. They also should retain granular information about exposures that can be useful for implementing effective hedge programs.

Certainly, exposure identification can be complex and challenging. It requires a clear understanding of your company's risk management objectives, good knowledge of the financial reporting of foreign currency transactions, effective communication between treasury and other corporate groups, and flexible and well-developed information systems. Given these varied requirements, it is not surprising that roughly half of the public firm survey respondents cited "accuracy and timeliness of data" as their greatest challenge, ahead of other issues such as "market volatility," "when to hedge," "using a proper strategy," and "hedge accounting and compliance." That said, accurate and timely exposure identification is an indispensable step in effectively managing foreign currency risk.

For questions or assistance with risk identification, contact your foreign exchange specialist.

Ramon Espinosa is a managing director based in San Francisco and head of Foreign Exchange Analytics. He can be reached at

In the spotlight

U.S. companies expect rise in international business activityThe results from Wells Fargo's inaugural International Business Indicator survey reveal that U.S. companies are optimistic about the future of their international business. Read more

69% - U.S. companies surveyed expecting international business activity to increase over the next year

The results from Wells Fargo's inaugural International Business Indicator survey reveal that U.S. companies are optimistic about the future of their international business. Nearly seven in 10 (69%) of the companies surveyed expect their international business activity to increase in the next year. Additionally, more than half anticipate that their international business will be more important to their company's overall financial success, both in terms of revenue and profit contributions.

Wells Fargo designed the International Business Indicator to help U.S. business leaders better understand and assess the global business environment. The report gauged the international business outlook of U.S. companies with annual revenues of $50 million or more conducting business across borders. The survey also looked at where companies are planning to expand, what's driving that expansion, and the obstacles that may hinder their expansion plans.

Increased activity mainly focused on U.S. neighbors and the Asia-Pacific region

Latin America, including Mexico, was the region most frequently mentioned to experience greater U.S. business activity in the coming year. About half of the companies surveyed also project business growth in Canada and the Asia-Pacific region. Although Latin America is the top focus for increasing business, Canada and China rank higher in terms of the business importance of the region, followed by Asia-Pacific.

Regions/countries where U.S. companies plan to increase business activity

Canada 49%, Latin America (including Mexico) 56%, Asia Pacific (excluding China) 48%, China 46%

Perhaps due to political tensions and a relative lack of exposure, the Middle East and Africa, along with Central and Eastern Europe, were the regions that received the least optimism and focus among the companies surveyed.

U.S. companies most frequently cited the competitive environment followed by economic conditions both outside of and within the U.S. as drivers for international expansion. On the flip side, the regulatory environments in the U.S. and other countries, along with labor costs and political stability, lead the list of factors hindering U.S. companies' ability to do business internationally.

Factors cited as barriers to international growth
(Top six factors shown)

IBI negative factors chart

When faced with these challenges to doing business globally, U.S. companies rely most heavily on feedback from their international customers and suppliers for guidance. Through these relationships, companies benefit from the practical insights that customers and suppliers can provide into navigating a particular country's business environment. This feedback ranks, by a wide margin, ahead of other information sources such as government agencies, industry or trade resources, consultants, or the news media.

Overall, the International Business Indicator survey revealed that despite the challenges of operating in different countries and cultures, U.S. companies view international expansion as essential to achieving long-term growth.

Screenshot form International Business Indicator video

To watch a short video summarizing the results of the International Business Indicator, click here. For additional information on the survey, including the full results, visit the International Business Indicator website.

Beginning next year, the Indicator survey will be conducted twice annually with the results released in the spring and fall. Over time, the International Business Indicator will become an even more valuable resource for U.S. companies developing their global strategies.

If you have any questions or comments regarding the Wells Fargo International Business Indicator, please contact


People power

Introducing Forouz Firoozi, Wells Fargo's International Treasury Management sales consultant for Southern CaliforniaShe may have settled into the sunny community of Irvine, Calif., but Forouz Firoozi, Wells Fargo's International Treasury Management sales consultant for Southern California, has an extensive international track-record. Read more

Photo of Forouz Firoozi

She may have settled into the sunny community of Irvine, Calif., but Forouz Firoozi, Wells Fargo's International Treasury Management sales consultant for Southern California, has an extensive international track-record.

At the age of 17, Forouz moved from her native Iran, off the coast of the Caspian Sea, to Stockholm, Sweden, as a guest student at the Royal Institute of Technology. After earning her bachelor's and master's degrees in electrical engineering, she worked in the telecom industry for companies including Ericsson and AT&T/Avaya. To leverage her passion for working with clients, Forouz — whose father was also a banker — transitioned to financial services in 2003 after obtaining her MBA from the Fuqua School of Business at Duke University in Durham, N.C. When describing her day-to-day interaction with customers, Forouz explains, "What we [Wells Fargo] do truly matters and impacts how our clients conduct business. I enjoy helping clients find ways to achieve greater success for their business."

Outside of work, Forouz enjoys spending time with her husband, who also works in banking, and her son, who is studying economics at the University of California, San Diego. "Raising my son is my proudest achievement. It's the highlight of my life, and he brings a smile to my face."

Although she is rooted in California, Forouz believes her travels have come full-circle. "I've found my way back to the coast, which reminds me a lot of my childhood spent on the shores of the Caspian Sea. I'm a beach girl. I love swimming and walking in the sand."

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General disclosures

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.