As the United Kingdom (UK) economy faces severe pressure, corporates continue to be negatively impacted by suppressed market confidence and foreign trade bottlenecks. Unresolved Brexit issues coupled with stringent lockdown measures have been key issues affecting normal operations for British importers and exporters, notwithstanding the prevailing bearish market sentiment on sterling.
Although these conditions exist, East & Partners’ (East) foreign exchange (FX) research demonstrates business’ ability to pre-empt exchange rate outcomes based on future expectations. This provides CFOs with some form of preparedness over volatile currency markets. However, in moments of extreme uncertainty caused by breaking events and unexpected announcements, all degrees of market anticipation fizzle out.
“As the FX market becomes more erratic due to global trade barriers and economic uncertainty, those best positioned to manage these risks fundamentally integrate technology, analysis and experience to derive a coherent outlook of future market conditions” commented East & Partners Markets Analyst, Pierre Sokoya
The relationship between expectations and exchange rates can be seen through a simple linear regression model where we regress corporates’ currency expectations on actual exchange rates for GBP/EUR.
The model produces an R^2 equalled to 0.17, which demonstrates that on average nearly one fifth of the variation in realised exchange rates for GBP/EUR can be explained by the variation in corporates’ expectations. Clearly, in an exuberant market the model will be less effective, whilst in a stable market the model will be more effective.
Currency Market Outlook
Why do corporates’ expectations blur in times of extreme volatility? Excess market volume is often a factor. Business’ FX volume account for only a small proportion of the total market volume, making them price takers rather than price makers.
According to figures from the Bank of England’s foreign exchange survey, around US$3 trillion of FX volume is transacted per day by the UK, with US$ 20 – 30 billion of this volume being transacted on sterling against euro alone. In periods where there is an influx of trading activity from large institutions and retail traders seeking to profit hunt on lucrative news releases, these circumstances will make past predictions obsolete and irrelevant.
For example, according to East’s currency research data, business’ six-monthly forecasts on the sterling against euro (GBP/EUR) had enough volume to move actual exchange rates in the anticipated direction between 2018 and 2019 – albeit not perfectly aligned. However, from the second half of 2019 this was not the case.
During the second half of 2019, the UK underwent a major general election which was strongly centred around Brexit. Such a major news event caused an abnormal surge in foreign exchange volume, particularly from large investment institutions. As a result, business’ initial forecasts on GBP/EUR formulated six months prior were completely blown out of the water.
"Business FX forecasts can shed some light on where currency
markets might go in the future, but it has more practical
application in monitoring the minds and attitudes of CFOs
towards the markets they’re engaged in"
- East & Partners Markets Analyst, Pierre Sokoya
GBP/EUR - Exchange Rate
Source: East & Partners UK Business FX Program (N = 2,212)
Risk Advisory Services
FX providers must keep track of both market conditions and corporates’ expectations because it will enable providers to recommend the correct hedging solutions at the right time. Risk advisory services are fundamental in helping businesses adapt their expectations with underlying market conditions for the foreseeable future.
"If they are [offering specialised covid-risk advice], we haven’t
seen it. We’d quite happily pay a service fee if they
brought this kind of value to the table"
- Group Treasurer, US$20 Bn Manufacturer
Interestingly, high street banks have been picking up ground in the risk management advisory space according to E&P’s UK Business FX program, which has translated into greater customer satisfaction over the past two years. For example, JP Morgan and Deutsche Bank are among the first investment banks to offer non-deliverable FX options to clients. This derivative allows clients to make cash settlement at a price difference between the agreed rate and the prevailing spot FX rate without the need for currency exchange. It enables clients to benefit from FX clearing on even the most illiquid currencies. Conversely, non-banks have recorded declining customer satisfaction for this critically important factor due to the lack of specialist support, product development and advice within non-banks. For example, in 2017 World First closed its corporate FX options business to focus more on developing payment solutions particularly for online e-commerce businesses.
HSBC, JPMorgan and Citi were rated as the top three banks for risk advice while SAXO, CMC Markets, and Monex were rated as the top three non-banks.
FX Risk Management Customer Satisfaction
Average Rating (1 = satisfied to 5 = dissatisfied)
Source: East & Partners UK Business FX Program (N = 2,212)
What's Next in Business FX?
Overall businesses are becoming increasingly confident about their position in FX. This is evident by the increasing level of Spot FX execution every six months across all revenue segments especially given current COVID related uncertainty.
Will these trends continue as the UK stands independent from the EU? Will businesses have the same successful responsiveness to currency markets as they have done in the past few years?
East’s global Business FX research program allows banks and financial institutions to closely monitor corporates expectations on a six-monthly basis. Interviews are conducted with over 2000 corporates throughout the UK covering all major sterling-based currencies pairs. Market segmentations between Micro, SME and Lower Corporate businesses are also provided.