During a volatile week in the currency markets, several Privalgo clients have been feeling the tension when making their international transactions. We’ve been working hard to ease the stress.
One, in particular, is a UK wine merchant. The company supplies catering companies, restaurants and bars with medium-to-high-end wine from France, Italy and the United States. Most of the wine they supply comes from California. The company buys over £400k of vino from the Golden State each week.
This means they’re exchanging £400k into dollars when they pay their invoices every Wednesday.
Thanks to some much-awaited data releases in the past few days, the wine merchant’s transactions were up against some potential jeopardy.
On Tuesday, CPI (Consumer Price Index) figures for June were released in the United States. As a measure of inflation, the data shows how much the overall price of goods and amenities have changed month on month.
Why does inflation matter?
Right now, inflation figures and central banks’ reactions to them are the name of the game when it comes to how a major currency will perform. Recent history has shown that when inflation pips higher, it can boost a country’s currency.
This is because the economic recovery from the global pandemic is causing economies to overheat. Eventually, central banks will have to tighten their monetary policies to tackle this rising inflation.
Changing monetary policy includes raising interest rates. Raising interest rates can cause a currency to appreciate, as it becomes more in demand from foreign investors.
We saw this happen to the value of the pound on Wednesday morning. UK inflation rose 2.5% month-on-month in June, exceeding 2.1% in May and outpacing expectations. Now, there’s more pressure on the Bank of England to shift its monetary policy. As a result, the pound appreciated circa 0.3%.
Wet hot American economy
It was a similar but more severe story on Tuesday in the US. The market expected June’s US CPI to come in lower than in May (4.9% down from 5%). This could have hurt the value of USD.
Or, in other words, good news for our wine merchant, who would enjoy a cheaper dollar when making their payments.
However, what the market anticipates isn’t always what happens.
If the CPI figures went against expectations, and inflation actually grew in June, then the dollar could have appreciated further against the pound. This would have been bad news for our wine merchant, who would be paying more in pounds to settle their imports from California.
Covering all bases
So there lies the risk that the wine merchant faced. If the US inflation figures came in hotter than expected, then the pound-to-dollar rate would likely move against them.
Last Friday, Patrick, the wine merchant’s contact at Privalgo, put forward the idea of partially hedging the payment. The client would lock in 50% of the payment (£400k) at Privalgo’s current exchange rate before the CPI data was released.
This way, if the inflation rate surprised the markets and the value of the dollar appreciated, 50% of the payment would be protected by the hedge. If the opposite happened: inflation cooled down and the dollar stayed the same or weakened, the client could take advantage of the rate with a same-day transaction.
It’s a smart way to cover both potential eventualities.
In reality, the inflation rate from Tuesday’s US CPI readings did in fact shock the markets. June’s figures surged to 5.4%, making core annual inflation the highest it’s been in the country since 1992.
Indeed, USD felt it. On Tuesday afternoon, the pound-to-US-dollar rate dropped over half a per cent, from 1.388 to 1.381. For the wine merchant, this difference would have cost them thousands on that week’s payment.
Luckily, they’d hedged 50% of payment, which softened the blow considerably and partially protected their budget.
Should the result have gone the other way, and the pound appreciated against the dollar, they still had the other 50% of the budget not hedged, which they could use to exploit the new and improved rate.
Going on from here
As the will-they-won’t-they debate about inflation and monetary policy rages on, the Privalgo team will continue to help the wine merchant and other clients protect their payments from the volatility that is coming.
If your business sends money abroad, then chances are it’ll be affected by market movement. See how we can help you mitigate the risks.
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