Published by Global Banking and Finance Review
Posted on February 20, 2025
By Shankar Ramakrishnan and Laura Matthews
(Reuters) - U.S. companies with overseas operations are taking advantage of lower rates in euros to slash their debt funding costs and soften the blow of higher interest rates with a hedging strategy that is expected to expand if the Fed continues to pause rate cuts and other central banks do not, bankers and corporate advisers said.
Demand for cross-currency swaps, a hedge where companies exchange loan principal and interest payments from one currency to another, has steadily picked up as interest rates between the United States and other major economies diverged.
"We have seen activity in both new cross-currency swap transactions and restructurings of existing hedges, mostly USD to EUR flows associated with net investment hedging activity," said John Wahr, head of rates sales in the derivative products group at U.S. Bank.
Generally, companies turn to cross-currency swaps when there is a positive carry and also a shield against volatility that can come from macroeconomic uncertainty over the impact President Donald Trump's tariffs and policies might have on inflation, interest rates and the U.S. economy.
Monthly EUR/USD cross-currency swaps increased 7% in January to $266 billion, versus the corresponding period in 2024, according to data from Clarus, an ION company that researches derivatives. The bankers and advisers told Reuters they could not name the companies doing such swaps, citing confidentiality reasons.
Within days of taking over, Trump began rapidly implementing his agenda, including tariffs on steel and aluminum imports and reciprocal tariffs, sparking volatility and raising concerns this could be inflationary and further pause an easing U.S. rate cycle. In another example, Trump on Tuesday said he plans to introduce tariffs on autos, pharmaceuticals and semiconductors.
Companies with overseas cash flows or significant investments in foreign operations can see their value fluctuate with changes in the exchange rate between the local currency and the dollar.
The net investment hedge mitigates that volatility because it offsets the changes in the value of those investments brought on by exchange rate gyrations.
By using cross-currency swaps to convert dollar interest payments to euro interest payments, companies can shave nearly 200 basis points off their interest costs, which could run up to millions of dollars, said Jackie Bowie, managing partner and head of risk management firm Chatham Financial.
Companies that started using cross-currency swaps last year, began restructuring them at the start of this year because those trades were more profitable as the euro weakened, said Amol Dhargalkar, managing partner at Chatham.
CURRENCY RISK
Companies were then using those profits for a variety of corporate purposes, including paying down debt, he added.
Still, the flow of swaps is tempered as treasurers were sensitive to creating derivative foreign exchange exposures that may heighten the risk of mark-to-market losses if the underlying foreign currencies were to strengthen, said Marc Fratepietro, co-head of global debt capital markets at Deutsche Bank.
If the foreign currency strengthened relative against the dollar, that could also eat into the interest expense savings for companies doing the swaps, said Eric Merlis, co-head of global markets, at Citizens in Boston.
But for companies that have yet to place these trades, it could still present an attractive entry point from both an interest rate differential and currency perspective, said Merlis, who is seeing companies across the board with exposures in the euro, Canadian dollar, and some dollar/Swiss franc take on the hedges.
"There's always uncertainty about what the Fed is going to do, or what the ECB is going to do. But this uncertainty has provided our clients with an opportunity to hedge against that macro uncertainty," he added.
The fragility of such trades was revealed somewhat on Wednesday when euro zone government bond yields rose to their highest in more than two weeks as investors focused on potential extra borrowing amid U.S.-Russia talks on Ukraine and comments from a European Central Bank official floating a pause to rate cuts.
(Reporting by Shankar Ramakrishnan and Laura Matthews; Editing by Anna Driver)
