As the U.S. presidential election looms, corporations are increasingly using foreign exchange options to hedge against potential currency volatility, driven by diverging central bank policies and political uncertainty.
Bollywood Fever: U.S. corporations are once again turning to foreign exchange options to safeguard their cash flow, anticipating that the upcoming U.S. presidential election and divergent central bank interest-rate policies could trigger currency volatility, according to industry insiders.
Bankers report that currency fluctuations, which can increase costs, disrupt cash flow, and impact earnings, are currently less severe than during the period from 2020 to 2022. This moderation has made option hedges more affordable compared to the peak prices seen during the COVID-19 pandemic and the initial wave of interest rate hikes by central banks aimed at controlling inflation.
A recent survey by currency trading platform MillTechFX found that 90% of U.S. companies plan to increase their purchase of options. Additionally, U.S. corporations hedged 48% of their currency exposure in the second quarter, up from 46% in the previous quarter, according to MillTechFX’s survey of 250 companies.
“As macroeconomic conditions evolve and potentially lead to increased currency volatility, companies are becoming more aware of the effects on their balance sheets,” said Nick Wood, head of execution at MillTechFX.
Options provide companies with the right to buy or sell currencies at a predetermined rate, helping them mitigate the impact of currency movements by locking in a worst-case exchange rate while still allowing them to benefit if the currency value rebounds.
Deutsche Bank’s currency VIX, which measures implied volatility of the world’s most traded currency pairs, is currently around 7.68, down from 13.67 in 2022.
Several bankers have noted a rise in demand for option hedges, indicating that many companies are seriously considering the risks posed by policy changes, especially with the upcoming November 5 election.
Republican U.S. presidential candidate Donald Trump has proposed policies such as hiking tariffs and curbing immigration, which economists warn could be inflationary. This might prompt the Federal Reserve to hike rates again, potentially strengthening the dollar, analysts suggest.
Democratic presidential nominee Vice President Kamala Harris‘ plans for housing assistance and curbing price gouging could have mixed effects on inflation, according to the Tax Policy Center.
U.S. corporate executives are increasingly discussing the election on earnings calls, particularly regarding tariffs and trade issues. “The election has quite a wide dispersion of outcomes for foreign exchange in general, mainly around some of the policies around tariffs,” said Garth Appelt, head of foreign exchange and emerging markets derivatives at Mizuho Americas, noting a “big pick up” in options use.
“So, even though volatility is low, it is allowing corporates the ability to buy protection at a cheap rate on events that can be quite market moving,” Appelt added.
Implied volatility on at-the-money options contracts for buying or selling British pounds or euros versus U.S. dollars a year from now is roughly 30% cheaper than two years ago, according to LSEG data.
Diverging central bank policies on interest rate cuts could also fuel currency fluctuations. Volatility spiked briefly earlier this month when investors unwound yen-funded trades after the Bank of Japan raised rates, reminding companies of the risks associated with currency exposure, said Thomas Kikis, global co-head of corporate sales for financial markets at Standard Chartered.
On Friday, Federal Reserve Chair Jerome Powell suggested it might be time to cut rates, though investors are uncertain about how far the U.S. central bank will go. This uncertainty has pushed the dollar down to an eight-month low against a basket of currencies on Monday.
“We are seeing people layering into hedges,” said Kikis. “It shows me that corporates have not taken their eyes off the ball.”
Collars, a hedging strategy that combines puts and calls, are becoming more popular, according to bankers. This strategy allows companies to benefit from any rise in currency value, unlike forwards, where the exchange rate is fixed.
Additionally, companies are employing exotic options to create strategies that protect their future cash flow in local currencies, particularly useful for transactions such as mergers and long-term investments, noted Appelt.
Paula Comings, head of FX sales at U.S. Bank, mentioned that her team has been assisting companies that are new to options in obtaining board approvals, as well as those returning to the market after a long hiatus. In one instance, a client sought options in six different currency pairs after several years away from the market, she said.
“Political tension is higher, both domestically and internationally, and economic uncertainty has risen,” Comings added.
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