Booming interest in currency forwards as USD strengthens
The United States dollar is enjoying a three decade high and fast outpacing all other major currencies.
In this post, we will take a look at how this impacts Asian economies and how forward contracts (or currency forward/FX forward) can help businesses to either take advantage of or guard against the rise.
USD – an overview
The United States dollar is currently trading at 109.44.
So far 2022 has seen the USD’s best performance since its all time high of 164.72 in February 1985.
Considering that as little as 12 months ago, some commentators were predicting the “death of the dollar” the trusty greenback’s stellar performance is rendered all the more impressive.
The reasons for the dollar’s strong show are multiple, but minimal exposure to the global energy crisis, lower than anticipated domestic inflation, and a favourable reception to the Fed’s monetary policies have all played a role.
Across the pond however, the British pound is entering a period of free fall, trading at $1.16, while the Euro has slumped to a 1:1 parity – something that would have been utterly unthinkable 12 months ago.
How this impacts Asian economies
As the demand for dollars soars, most major currencies have fallen against it and developing markets are particularly exposed.
In Asia, the Chinese Renminbi is down 5.7% (the damage partially offset by China’s $3 trillion of dollar reserves), the Indian Rupee and Thai Baht both down 7%, and the Japanese Yen has been even harder hit now trading just at $1 – 143JPY.
But of course, even across Asia there are some beneficiaries of the strong dollar.
For example, many Asian businesses export to the US (largely to the detriment of US manufacturers by the way) and if these exporters are getting paid in dollars, then they will find that those dollars now buy them more Yuan, Rupees or Baht than they previously could, increasing their domestic wealth.
On the other hand, an Asian business that needs to buy dollars, or maybe acquires parts or services from within the US, will find that it is becoming a lot more expensive to do so.
How currency forwards are used and how they defend against currency movements
A Currency forward (sometimes called an FX forward) is an agreement made in the foreign exchange market that basically ‘lock in’ an exchange rate for the future purchase or sale of a currency.
For example, let’s say that we know our business will need $100,000 over the next 12 months.
Well we can enter into a USD forward contract to buy the $100k any time within the next 12 months, but at today’s exchange rate.
This protects us from any future fluctuations in the exchange rate and also provides certainty from a budgeting perspective.
Swap contract v forward
While swap and forward contracts are sometimes confused they are not actually the same thing at all.
As we have covered, a forward contract is an agreement to buy a currency at a fixed rate within a fixed time period whereas a swap contract is where parties agree to exchange cash flows on an agreed future date.
When is the right time to use or not use an FX Forward?
Of course, with the USD so high right now, not too many Asian businesses would be keen to lock in this exchange rate and many are actually holding off on making an exchange right now in the hope that it comes down sometime soon.
Anybody who enters into a JPYUSD forward today may end up kicking themselves if the dollar drops in 2 months time.
On the other hand, a US business that knows it will need Asian currencies in the near future may well wish to lock in this almost historic exchange rate in order to maximise the dollar’s position.
Is now the time to book a USD forward contract?
Generally, the main reasons for booking a forward is when a party wishes to take advantage of an unusually favourable exchange rate, or when it simply needs certainty for budgeting reasons.
The current dollar rate is certainly unusually favourable for any business with a reserve of dollars so this may well be an opportune time to enter into a USD forward contract.
For example, a US based firm that makes a USDCNY Forward today would be capitalizing on the excellent dollar to yuan rate.
Final thoughts on USD forward contracts
The strength of the US dollar will continue to have implications on Asian economies and as we have seen, there are both winners and losers.
However, anybody looking to lock in the current rates for whatever reason can explore the possibility of currency Forward or FX forward.