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The 2021 FX landscape: Evolving in a pandemic era

theme 46 - Global Banking | Finance

By George Vessey, Currency Strategist at Western Union

Volatility and uncertainty

As a turbulent year draws to a close, being ready for whatever lies ahead is more important than ever for businesses, however knowing how to be fully futureproofed is tough. The rise of geopolitical themes such as trade wars, and the growing influence of political figures on financial markets, have gradually but significantly increased the complexity around judging future market trends and their implications for international business. Now, adding COVID-19 to the mix has brought a whole new dimension to global markets analysis.

The pandemic has triggered a broad and rapid disruption to economies, technology and infrastructure worldwide. The global business arena is now under enormous pressure to bounce back. After all, the world is still living through its most severe economic downturn in modern history. Amidst the Great Lockdown, more than 90% of countries could experience an annual economic contraction, while emerging markets collectively are at risk of recording their first year without growth in at least 60 years. The timing of a return to pre-crisis economic levels remains highly uncertain and reliance on the success of newly developed vaccines gives the recovery a more binary character which polarizes any forecasts for next year. Fortunately, the positive vaccine developments over recent weeks have boosted recovery prospects and inflated risk appetite across financial markets, prompting a shift in investors’ portfolios towards cyclicals, which should be positive for the UK market.

As we look ahead to 2021, exchange rate volatility jumps to the forefront, given it has a vast impact on the profitability of international trade in goods and services. As companies now transition into the ‘new normal’ and re-structure plans for next year, the risks to financial objectives from economic and currency fluctuations remain acute.

A range of challenges across GBP, USD, EUR and AUD

After years of having relatively higher interest rates, US rates are now in line with other developed nations: near zero. Recently, the dollar has been notching fresh 2 ½-year lows regularly. The rise in risk appetite globally has seen an extension of the rotation of capital from safer assets, like the US Dollar, into riskier higher-yielding investments, like stocks, copper, oil, emerging market and commodity currencies.

Should this dollar-weakening trend continue, 2021 may allow GBP/USD to press into the higher realms of the $1.30s. On the other hand, there aren’t many positive catalysts driving the pound either. Growing speculation about further UK rate cuts may limit sterling upside as negative interest rate policy remains in active review by the BOE. A UK-EU deal, due by 31 December, also remains a major uncertainty, which has the potential to drag GBP/USD back under $1.20.

George Vessey

George Vessey

As to GBP/EUR – the trajectory may largely depend on how successful the global economic recovery is. Will the UK and Europe differ in their recovery speeds, especially bearing in mind the UK’s go-ahead for the Pfizer and BioNTech vaccine? And how will a potential second or third wave of the virus be managed by governments in both areas? The long-lasting impact of coronavirus on the economies of both the UK and the Eurozone may not be realized until late 2020 or even 2021, due to the huge support by policymakers in both regions to help protect jobs and reduce bankruptcies.

A no-trade deal Brexit is also a key risk lingering over both regions, though the UK and thus the pound is expected to suffer more so in the short run. After all, the UK currency’s sensitivity to negative Brexit headlines is significant, with GBP/EUR dropping as soon the media suggests that Brexit trade talks are hanging in the balance. Expectations of GBP/EUR falling towards parity in such a scenario are growing, particularly if it also prompts a Scottish independence referendum. Conversely, a trade deal should help GBP/EUR climb towards €1.20.

The unfolding effect of COVID-19 impacts the Aussie, too. The trajectory of GBP/AUD largely depends on whether a second or third wave of coronavirus scuppers economic recovery hopes and sparks risk aversion across financial markets. Historically, the AUD outperforms the pound during times of economic recovery.

If financial markets reel in the event of a new round of lockdown measures, then investors may ditch high yielding assets, including the Aussie dollar. As per the trend in March, GBP/AUD may drift higher as a result. China plays a key factor here too – with the country embroiled in several economic and geopolitical disputes, including with the UK and Australia. An escalation of these disputes could lead to economic sanctions, posing a serious threat to Australia’s recovery hopes.

Preparation, preparation, preparation

While it is therefore nigh on impossible for businesses worldwide to know exactly what lies ahead, and while there is no one size fits all approach to FX risk management, the overarching objective to achieve cash flow certainty and protect profits from the effects of FX rate movements must remain the same. While future scenario testing and subsequent risk analysis remains an incredible challenge for many companies, this remains vital for many businesses when it comes to navigating currency volatility.

Looking ahead to 2021, it is important that business decision makers stay focused on the basic building blocks of hedge strategy development, and that throughout the festive season and into 2021, tactics employed are regularly reviewed to ensure that every company’s FX risk management objectives continue to be met.

Global Banking & Finance Review

 

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