US multinational companies are starting to reevaluate their currency hedging strategies after a surge in the dollar in recent months, as the impact of the stronger greenback starts to show up in second-quarter corporate earnings.
A stronger dollar claimed Netflix Inc as its first victim of the earnings season on Monday.
The company, which does not hedge its revenue with derivatives, said foreign exchange rates pushed its expectations on the 2018 operating margin to near the lower end of its target range.
“This will be another wake-up call,” said Wolfgang Koester, chief executive at currency risk consulting firm FiREapps, in Scottsdale, Arizona. “There are still a lot of companies that don’t manage this well enough.”
The dollar gained more than 5% against major trading partners’ currencies in the second quarter, supported by rising trade war tensions and a hawkish Federal Reserve.
The dollar index, which at the start of the second quarter had been down about 11% year-over-year, rose to finish the quarter nearly flat on a year-over-year basis.
The dollar’s rise has emerged as a surprise risk at the start of what is otherwise expected to be a robust US corporate earnings season.
Foreign currency earnings of US multinational companies are worth less in dollars when the currency is stronger.
Banks said their inquiries from clients had gone up recently.
“Our volume of hedging activities increased from clients from April or May until now,” said Kuniyuki Hirai, head of foreign exchange trading for MUFG in New York.
The dollar’s recent strength is a sharp departure from its weakening trend in 2017, when it delivered a boost to large US companies and may have made managing currency risks less of a priority. Some analysts expect a rise in trade protectionism to boost the greenback in the near term, which could mean more companies are likely to cite the stronger dollar for future earnings weakness.
“We get more questions about hedging when currency moves,” said Roberto Battistuzzi, director of foreign exchange sales at Credit Suisse. “If anything, it allows companies to take the opportunity to see how the programs are performing.”
Bryan Morales, a director in Citizens Bank’s global markets group, said there had been some pickup in hedging demand recently, with the Federal Reserve hiking rates.
Interest rate differences between countries drive hedging costs, and as the Fed raises interest rates it can become more attractive to hedge.
The Fed has raised rates twice already this year and is expected to raise rates one or two more times by year end.
“It’s provided more opportunity for clients hesitant about hedging to take advantage of a premium,” Morales said.
Netflix is an example of currency risks faced by companies that do a lot of their business in international markets, even as the vast majority of their costs remain dollar-denominated.
The company, which does not plan to change its stance on currency hedging, will try to move more of its costs offshore, to help create a natural hedge, a Netflix spokesman said.
That approach is favoured by an increasing number of companies.
Bob Doll, senior portfolio manager and chief equity strategist at Nuveen Asset Management, in Princeton, New Jersey, said natural hedging is being relied on “more and more” by companies, “particularly as they become more global and have so many currency relationships.”
But there are limits to the strategy. “It’s rare in these industries that you can have a full natural hedge position,” said Amo Sahota, director at Klarity FX in San Francisco. “We expect to see the market start to return to more traditional long-term hedging programmes.”
Oracle Corp is among other companies that have mentioned the dollar as a headwind while Carnival Corp and Akamai Technologies have also talked in recent months about the adverse impact from the dollar.
Bank of America Merrill Lynch estimates that a sustained 10% appreciation in the dollar against the euro results in a reduction in S&P 500 earnings per share of 3% to 4%.
“Right now there are a number of companies out there which are still reporting the positive impact of currency valuations from the 2017 dollar weakness,” Sahota said. “But that’s quickly going to turn around as they start to get the impact from the first half of 2018.”
For the second quarter, year-over-year profit growth for all S&P 500 companies is estimated at 21.4%, according to Thomson Reuters data.
That follows earnings growth of 26.6% in the first quarter.
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