Entrepreneur, save your currency now

The tension in the currency markets is easing as the political risks in Europe disappear. The savvy traders can use this relative calm to buy protection against currency risks at a low cost.

After a wild ride in 2016, calm has returned to the currency markets in recent weeks. Less than a year ago, the unexpected result of the Brexit referendum caused the pound to fall by more than 10 percent against the euro. 6 percent down.

For companies that do business across borders, without hedging currency risk, these exchange rate shocks can make the difference between a nice profit and a painful loss.

Uncertainty made protection expensive
It was also not a pleasant period for entrepreneurs who have chosen to hedge the currency risk. The price for this protection shot up considerably. The value of a currency option is partly determined by the expected volatility of the underlying currency pair. In recent months, the prices of currency options rose as the market was concerned about the possible outcome of the elections in the Netherlands and France, among others.

Political relief
That fear has ebbed after the Dutch elections to the House of Representatives and the French presidential elections. The CDU's signed victory in the elections in the German state of North Rhine-Westphalia also allays fears that the Bundestag elections (at the end of September) will take an unexpected turn. In Europe, political fear has turned into political relief. An important consequence of this is that the price for protection has not been as low as it is now in more than 2 years.

Remarkably quiet
In addition to currency markets, it is also remarkably quiet in other parts of the financial world. In this regard, the extremely low level of the VIX stands out. The VIX measures the size of the price movements that investors are pricing in for the US stock index S&P 500. In recent weeks, the VIX has hovered around a level of 10. That is almost half the average level of the past 10 years. In the meantime, there were peaks of (well) above 40, for example during the credit crisis and the European debt crisis.

Silence before the storm?
Political risk has diminished in recent months. Besides the European elections, there are many more factors that could lead to mounting tensions in the financial markets. This ranges from a new Trump measure to geopolitical tensions over North Korea or an unexpected turn in the Brexit negotiations.

In short: instead of enjoying the relative calm, entrepreneurs can better use it to hedge the currency risk at low cost.

Lawrence Martins

Laurens Maartens is a currency expert at the Dutch Payment and Exchange Company (NBWM). Maartens analyzes current currency developments and also provides lectures and training in the field of currency management.

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