Making Sense Together with moneycorp

Understanding the Canadian Dollar and how companies can protect their bottom line.

July 28, 2020 moneycorp Episode 3
Making Sense Together with moneycorp
Understanding the Canadian Dollar and how companies can protect their bottom line.
Chapters
Making Sense Together with moneycorp
Understanding the Canadian Dollar and how companies can protect their bottom line.
Jul 28, 2020 Episode 3
moneycorp

We all know about COVID-19 impact on the world, but what about its influence to global currencies? In this podcast, we’ll dig deep to understand the Canadian dollar during the pandemic and what companies should do if they want to protect their bottom line. In this episode we talk about:

  • How the Canadian Dollar fits into global FX markets. 
  • Which key drivers influence the Canadian Dollar?
  • Coronavirus Impact.
  • What can companies do given the current FX volatility?
  • What is hedging and why should companies be using it?
  • Specific products and strategies that will work for clients.
  • Moneycorp’s recent launch of FX services in Canada.
Show Notes Transcript

We all know about COVID-19 impact on the world, but what about its influence to global currencies? In this podcast, we’ll dig deep to understand the Canadian dollar during the pandemic and what companies should do if they want to protect their bottom line. In this episode we talk about:

  • How the Canadian Dollar fits into global FX markets. 
  • Which key drivers influence the Canadian Dollar?
  • Coronavirus Impact.
  • What can companies do given the current FX volatility?
  • What is hedging and why should companies be using it?
  • Specific products and strategies that will work for clients.
  • Moneycorp’s recent launch of FX services in Canada.

INTRO (ANIL): Welcome to Making Sense Together with moneycorp where we’ll talk about COVID-19’s impact on the Canadian dollar and what companies should do if they want to protect their bottom line. I’m Anil Sawrup and your host for today. I’m also joined by Lugesan Reddy, President of Speciality Forex. Lugesan has been involved in the FX Industry for over a decade, helping many organizations around the world with the management of their foreign exchange exposures. He is a designated Chartered Financial Analyst as well as being a Certified Treasury Professional. Welcome!

 

LUGESAN: Thanks Anil. It’s a real pleasure to be here.

 

ANIL: We are especially excited to have you on the show today. Can you tell us a little bit about your consulting firm, Speciality Forex? 

 

LUGESAN: Sure! Speciality Forex is a new company. We started our operations in May this year and our focus is on helping businesses increase their profitability by employing better foreign exchange strategies. Over the years we have noticed a gap in Canada where many corporates do not have the time, resources or even expertise to focus on foreign exchange (as you know Anil, Foreign Exchange is a full time job on its own and requires constant focus). So, by using Speciality Forex, companies can focus on growing their core business while knowing that their foreign exchange activities are well taken care of – ingredients that can generate greater returns. 

 

ANIL: Great, thanks for that Lugesan and all the best with your new company. So let’s jump right in! Can you give us an overview of the Canadian dollar and how it fits into FX markets?

 

LUGESAN: No problem. The Canadian dollar, also known as the Loonie, is a G10 currency which means it is one of the top 10 most popular and most liquid currencies in the world. Almost 2% of the world’s FX reserves are held in Canadian Dollars, ranking it number 6 for this purpose. Only the US Dollar, Euro, Great British Pound, Japanese Yen and Chinese Renminbi are ranked higher. It is also important to note that Canada is a developed market and as such, the Canadian Dollar is grouped amongst the currencies of other developed economies (such as the USA, Australia, and the UK). Whereas, emerging market economies like Kenya, Vietnam and India represent high growth rates and high investment yields for the larger risks taken, the Canadian economy is known for its stability, low yields, and less investment risk.    

 

ANIL: Very insightful Lugesan. You mention that the Canadian Dollar is known for its safety. Has this always been the case? Given its extreme volatility in recent months, what are currently some of the key drivers that affect its value?

 

LUGESAN: Great questions. As we all know, Canada has really close ties with the US. Being our largest trading partner, economic growth in the US often leads to economic growth in Canada due to larger volumes of imports by our neighbours. Over the past few years however, we have seen a gradual de-coupling between Canada and the US. For one, USA are now producing their own shale oil which has reduce some of their dependence on Canada. Tariff increases on Canadian imports are also causing a gap between the 2 country’s dependencies. The USMCA deal is another event which spurred a conflict and a gap between the US and Canada. I have also been speaking to a lot of businesses who are considering importing directly from other international counterparties instead of importing through the US (which has historically been the norm for many). This is a sign that the de-coupling I have mentioned could get stronger.

 

So, the Canadian Dollar is seen more and more on its own over the years and not closely related to the US Dollar. This means that global risk aversion would affect Canada’s currency negatively as investors flock to safe-haven assets such as US Treasuries and Gold. 

 

In terms of current key drivers that affect the Loonie, it must be mentioned that one of the largest contributors to Canada’s economy is that of oil. There is an extremely high correlation between the Canadian Dollar and oil prices. For instance, the oil crisis towards the end of 2018 saw the Canadian Dollar depreciate considerably against other currencies. It should also be mentioned that Canada’s debt has grown faster than its economy in recent years, rendering it extremely sensitive to interest rate changes. The Bank of Canada’s monetary policy decisions typically have a huge impact on the Canadian Dollar. And lastly, factors that influence global risk sentiment are having a larger and larger impact on the Loonie. We are seeing more volatile swings in the currency due to US-China tensions, the Coronavirus impact and other world events that affect global risk sentiment.

 

ANIL: You’ve mentioned the Coronavirus impact. I’d like to ask you a tough question which is on a lot of people’s minds. How has Covid impacted the Canadian dollar and what can we expect? 

 

LUGESAN: Well, The COVID impact has been detrimental to many economies and currencies worldwide. During the start of the pandemic, the Loonie was hit negatively by 2 events not just one. Not only did global risk aversion spike because of COVID concerns and talks of economic lockdowns, but the oil dispute between Saudi Arabia and Russia did not help oil markets and consequently the Canadian Dollar as well. We saw USDCAD jump to the mid 1.40s during this time before settling back down into the mid 1.30s.

 

Now, no one knows how long COVID will last and what we have in store for us for the near future. It is likely though that if we have positive news regarding COVID, we will likely see oil prices rise on increased demand and global risk sentiment rise as well. Both factors will support the Canadian Dollar. However, should we see negative news being released, both the oil markets and the Loonie will likely take a hit. In essence, the Canadian Dollar will be more sensitive than some of the other developed market currencies due to its strong correlation with oil and with global risk sentiment. Central Bank actions in terms of stimulus packages and monetary policy decisions will also affect the currency and should be monitored closely during these COVID times as well.

 

ANIL: So, is it fair to say with the supply and demand of oil, if a second wave of the virus were to occur, we could see another slip in oil prices which would directly correlate with the Canadian dollar?

 

LUGESAN: Yes, definitely. Over the past few weeks, we saw a nice uptick in oil with the Canadian Dollar strengthening by over 3 cents. This correlation is likely going to continue. If a second wave of the virus becomes more significant, oil prices would drop due to lower demand concerns which will likely weaken the Canadian Dollar as well. We have seen tremendous progress with regards to a COVID vaccine however, and if a vaccine does come into fruition, it could lead to significant strength for oil and for the Loonie. One also needs to be weary of OPEC’s decisions moving forward. Should they reduce their record levels of production cuts, thereby increasing oil supply, this could reduce oil prices and therefore impact the Canadian Dollar negatively.

 

ANIL: Thanks Lugesan, so given the high FX volatility we are currently seeing in the market, what can companies do? 

 

LUGESAN: Companies need to protect their profitability by engaging in hedging activities. Now, at this junction, I think it is important to understand the difference between hedging versus trading. With hedging, the objective is to reduce risk and protect profits. With Trading, the objective is to increase risk and expose profits with the aim of increasing it even more. For companies, whose revenues are earned through their core business and not through FX, it is important that they protect their profits by engaging in hedging activities.

 

ANIL: So common feedback I get is that “I don’t like to hedge because it’s like gambling”. Maybe you can explain to our listeners what is hedging and is it really that similar to gambling?

 

LUGESAN: Well Anil, keeping in line with the gambling analogy, being in FX markets is like being in a Casino. In both places, you can make excess money, or you can lose money depending on the outcomes. If your business is exposed to exchange rates, you unfortunately have your money on the gambling table and you risk losing some or all of it. Now, hedging allows you to take your money off the gambling table and keep it safely in your back pocket. While you won’t gain extra cash should the outcomes be in your favour, you wouldn’t lose too much either should things go against you. 

 

Companies who have expenses to pay with the money that’s on the gambling table (rent money as I collectively like to call it), should look at safeguard these monies instead of risking it. There are no issues at all if companies want to earn a return from FX markets. However, they first need to segregate their rent money from their excess money (or spending money for that matter) and ensure that they employ the right strategies for both purposes. Use hedging strategies to keep their rent money safely in their back pocket, and trading strategies to try to increase their spending money that is on the table. They also need to employ the right metrics to judge performance of each strategy and ensure they do not use trading metrics to judge how their hedging strategies are doing. A common mistake made by many companies.

 

ANIL: That makes sense. So what kind of products should a company use for hedging or is there specific strategies that would work for a client?

 

LUGESAN: Essentially clients need to ask themselves 2 questions. First, they need to look internally within their business, determine the effect of exchange rate fluctuations on their cash flows, and then answer the question: “How much protection does my business need?”. Then, and only then, should they look at what the markets are doing and answer the second question which is “Once I’ve found out how much protection my business needs, what is the best way to fund that protection?” This is when companies should focus on the markets, understand investor sentiment, and compare the different products and strategies that are available to them. Now, there are a lot of products available. Companies can use spots, forwards, or different combinations of options. Therefore, it is vital to first answer the question: “How much protection does my business need?” This will ensure they do not pay too much and over-protect their business or pay too little and under-protect their business.

 

ANIL: Great, anything else that’s important when using hedging contracts? 

 

LUGESAN: Definitely. We’ve seen from COVID that a company’s cash flows can become very unpredictable. Even if a company expects smooth and constant cash flows, external events can really change circumstances tremendously. So, when working with an FX Provider, it is important to ensure that one of the features offered, is the flexibility to manipulate contract maturities. We’ve seen with COVID that many companies have had their cash flows stop completely because of the economic lockdowns, yet some of their hedging contracts became due during this time. Working with providers who can extend or pre-deliver on existing FX contracts adds a lot of flexibility which is vitally important to businesses during times of need.

 

This flexibility was particularly handy for one of my clients during the beginning of 2019. During this time, we saw the Canadian Dollar depreciate considerably against the US Dollar. This company had their US Dollar receivables delayed by factors out of their control. Not only did we extend some of their hedging contracts falling due at the time, but when it was possible, we allowed them to partake in the attractive exchange rates as best we could by blending their hedged rates with the much better spot rates each time they settled. Over a short period, they were able to use up their contracts and still partake in favourable exchange rate movements a little. A win-win result due to having flexibility.

 

ANIL: Thank you for that insight and giving us a better understanding on hedging in these unprecedented times. As we mentioned previously, moneycorp just entered into the Canadian market by offering our FX and risk management services. Being an independent FX consultant yourself, what are your thoughts on our new initiative? 

 

LUGESAN: I think it’s fantastic! Having a new FX provider in Canada empowers the end user and strengthens competition. Existing providers may need to up their game or risk losing clients. All this means is an overall improvement in service delivery, so I think it’s fantastic. 

 

OUTRO (ANIL): Great! Lugesan, thanks again for joining us today! 

 

LUGESAN: Thank you, it was a real pleasure to be here! I’m excited for what Moneycorp can do for our Canadian economy and it will be great to see the impact. 

 

ANIL: To our listeners, thanks for tuning in to Making Sense Together with Moneycorp! If you like our show and want to know more, check us out at moneycorp.com or follow us on LinkedIn, Facebook, and Twitter at moneycorp Americas.