COVID-19 has been the single biggest cause for the turbulency we have been witnessing in the markets over the past 7 months. We’ve had a catastrophic few days in March with several record-breaking day point drops, and since, we’re left with an uncertain future and difficult risk management.
The biggest issue is that we haven’t encountered social distancing and lockdowns in several generations, and some countries haven’t ever. Whilst most societies are finally getting to grips with controlling COVID-19, the business grants are running dry and we’re beginning to see a rise in unemployment.
The US is a good example of the economic damage caused by COVID-19. In June, there were many reports suggesting unemployment is rising. These come at the same time that the $600 weekly supplement for jobless benefits came to an end. There were various signals pointing towards an imminent recession. Of course, it already had. In June, the US officially entered recession.
Whilst this was stipulated by experts to not be a normal downturn, and was a temporary issue regarding lockdown, it certainly didn’t help the US Dollar. The USD has been devaluing since May, in which it saw an accelerated drop mid-June against the Euro.
Even in Asian countries where coronavirus has been much better contained, there are economic ramifications from social distancing. In the scenario of there being no direct recession, there’s still the matter of currency, which affects every country, and particularly the international businesses within it. This article will explore the dangers that Coronavirus is having on currency, and why it’s more than just devaluing that’s to worry about.
Spike in retail investors causing havoc
COVID-19 has brought on many unexpected economic implications, but one not many saw coming was the rising of retail investors. Research conducted by Paderborn University in Germany found that retail investors increased their activity by 13.9% for every doubling of active Coronavirus cases over a time period of several months – an odd correlation.
Investors were found to be likely engaged in short selling, suggesting that the economic turbulence itself is what’s attractive to retail investors as they try to capitalise on large swings in prices.
Behavioural finance expert Dan Egan claims that there’s a rise in “entertainment investing”. Egan also claims that a lot of this money is what’s been saved from a reduction in spending over summer, with many stores and entertainment services closed or heavily restricted. In fact, the huge influx of retail investors in the Malaysian stock market actually helped recoup almost all of its 2020 losses. This is almost unheard of in a market that’s mostly dominated by investment banks and trading algorithms.
This is also supplemented with easily accessible investing apps, which make Forex as simple as sports betting. In fact, without sports matches being played, this could be another factor in its popularity. Many Forex companies are offering sign up bonuses, referral schemes and social investing (automated copycat trading, like with eToro). This, whilst it’s a positive development, may cause more unpredictable behaviour in markets such as currency.
We’ve even seen some of the biggest and most successful quantitative hedge funds struggle with the influx of retail investors. It’s possible that all of the new money and uneducated gambling has glitched the algorithms into making poor judgements. For example, Two Sigma, DE Shaw and RenTech, all of which are consistently successful, all saw losses during Easter on some of their funds.
The Dollar and CNY Slides
The short term gains that the US saw briefly in Easter were emotional, short-term dives into a safe haven currency. As time goes by and the long-term economic outlook begins to become more clear, which is one of political instability, vast government spending and rising unemployment, we quickly begin to see the USD slide. Whilst it continues to do so, the most noteworthy observation is its high volatility, along with other currencies.
Recently, the selldown has slowed somewhat due to lackluster Chinese economic data, meaning that some have switched back to buying US bonds. The Chinese Yuan is another currency that has been seeing a drop in price since May against the Euro.
How this affects small businesses
First and foremost, volatility in currencies affects international small businesses a great deal because of the lack of certainty. We can see the rise in companies dealing with international money transfers as good evidence for these unnerving currency developments, as small companies turn to hedging and cheaper rates offered by fintech alternatives.
Dealing in multiple currencies and having international suppliers means that the business is having to buy or convert currency regularly. If you only have a tight gross profit margin, this is being completely eaten into with currency swings.
For example, €10,000 worth of European headphones for your American business would have cost $10,752 in May. Today, it costs $11,850. This is over $1,000 more on one order within the space of a few months, and can seriously damage profit margins. After all, this is now 10% more expensive, which could be half of a 20% profit margin.
The second way it affects businesses is that if they mainly deal in the USD, they’re being hurt by the declining dollar. For international businesses outside of America, demand from Americans may be hurt as your different-currency services. For example a Spanish SaaS company is now relatively more expensive for USD clients. If goods or services for non-Americans are sold in USD, then the exchange back to base currency is going to be pricey.
How hedging is saving many businesses
COVID-19 may have already shook up the markets, but it’s far from the end of it. We’re in the dark regarding the extent of the upcoming volatility, which makes risk management as difficult as it can be.
The best way to mitigate risk, is to insure against it. Hedging products allow for this in a variety of forms, and is likely why they’re becoming democratised into easily accessible platforms now (i.e. Money Transfer Companies, as mentioned earlier) – the demand is certainly there.
For example, businesses operating in the USA that deal in EUR would have benefited greatly if they hedged the Euro back in May. Purchasing a forward contract would have meant they receive May’s price (a pre-agreed price based on today’s price) for the Euro for a specific date in the future. For that contract, they will have paid a fee far smaller than the eventual loss that’s been realised.
For businesses who aren’t sure which way the currency may swing and feel a Forward contract is, in that instance, merely another gamble, then Option contacts are a perfect replacement. With options, companies have the option of whether or not they want to execute the future transaction at the pre-agreed price, unlike Forward hedging which is a locked-in commitment. This caters to a highly volatile market which isn’t confidentially forecasted, as it’s there if you need it.
Banks fail at meeting hedging demand
Most highstreet banks fail to transparently offer hedging products to small business account holders. Many do not offer them at all, whilst others have been in trouble in recent years for mis-selling products. There are exceptions of course, and many banks will hedge for large corporations, but it’s not currently on their radar when it comes to meeting smaller contracts.
Even challenger banks, such as Starling, who are marketed as the fintech alternative to the outdated bank, still fail to offer hedging products. This is another reason behind the rise of Money transfer companies, which have relished in meeting this demand with offering accessible FX services.
The FX market for a long time catered only to large corporations. There were high minimum transfers, phone calls with brokers and long waiting times. Today, there’s an app – and that’s it. Whilst there’s many to choose from, Money Transfer apps are exceedingly easy to use and are partly responsible for this rise in retail investing.
Most have access to the interbanking rate, meaning that currency is offered at ultra competitive rates. This is enough, in this market, to attract users given the devaluing of many currencies. Within this umbrella term, there are specialists that offer hedging products, yet they keep the accessible, user friendly approach. Thus, it’s never been easier to hedge and protect against currency swings.
This is a surprise to many who rely on high street banks for all of their financial products: a mortgage, savings account, current account, business account, car loan and so on. There are benefits to using a centralised entity, but when they fail to offer even the most basic FX services, it’s only a matter of time that they’re entirely left behind for fintech alternatives.
