Currency Pulse #28 — Friendshoring & FX Management

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‘Friendshoring’ describes the trade practice where supply chain networks are focused on countries regarded as political and economic allies. Add an element of ‘nearshoring’ —the process of relocating business operations to a nearby country—, and you get a description of the burgeoning commercial relationship between Mexico and the U.S.

As Mexican and foreign companies operating in Mexico develop a footprint in capital goods, materials, automobiles and components, and food and beverage, the implications for FX risk managers are becoming momentous.?

According to CME Group, on June 3, the day after the Mexican election, a record $7.5 billion notional of MXN futures were traded, the highest ever on a non-roll day. MXN futures average daily volume is running at a record $3.66 billion

"The ecosystem for the Mexican peso has got a lot more diversified. There are a lot more people now active and there are a lot more firms active in it than ever before" — Phil Hermon, CME Group

A Bloomberg News article adds: "There is evidence of increasing hedging activity. Commercial traders, who tap the currency and options markets for protection, increased peso shorts in April to some 145,000 contracts worth approximately $4.5 bn" (*).

In recent years, the super-peso has led to a "pretty dramatic change in the cost of goods sold for companies". One company cited in the article had to lower 2024 estimates by $50 million. As always, pricing parameters will play a determinant role.

Firms with flexible pricing strategies "haven't felt the need to hedge yet". For other Mexico-based exporters —especially those lacking pricing power—, layered hedging programs are bound to become very popular, as Esteban Lopez argues.

Secondary objectives —including forward points optimisation—, will also be top of mind, as MXN trades at a 5.45% one-year discount to USD.

(*) Carter Johnson, Kelsey Butler & Michael O'Boyle: "Multinationals Are Seeking Protection Against the Super Peso", Bloomberg, June 2024.

Case Study: L’Occitane

L’Occitane Group, a leading international manufacturer and retailer of sustainable beauty and wellness products, uses Kantox solutions to manage currency risk in 15 currency pairs. The balance sheet hedging program aims at removing FX gains and losses on an exposure of €368m.

This was achieved by means of a micro-hedging program for invoices, allowing the firm to save as much as €188,684 annually on forward points (sales in currencies that trade at a forward discount to EUR) [more info].

“Automation offers far more than simply removing manual tasks from the treasurer’s to-do list. It supports strategic thinking and enables the treasury to add greater value to the organisation.” — Quentin Jarret, L’Occitane Group

Here’s a view of L’Occitane’s automated FX workflow:

Hedging The Budget, Part II: Clearing Up Misconceptions

In this second blog devoted to a step-by-step approach to hedging the budget, we clear up some of the most common misconceptions regarding:

• The confusion between campaign and budget periods. The rule: always hedge the budget of a specific campaign.

• Setting an inadequate budget rate. The choice of the budget rate may fall short in terms of attainability and stability—we show how this can be improved.

• Hedging right away. This classical approach puts companies at the mercy of their degree of forecast accuracy.?

Read the entire blog ?? here.

Merck & Hermès

In the latest episode of CurrencyCast, Kantox’s Agustin Mackinlay attempts to reverse-engineer the FX risk management strategies of Merck KGaA, the Darmstadt-based global pharmaceutical company, and Hermès, one of the dominant companies in the high-end luxury goods sector.?

While Merck applies the full gamut of FX risk management techniques, Hermès has recently announced that the 42.1% operating margin achieved in 2023 —the highest ever for the company— was partly due to the favourable impact of currency hedging.

Watch the entire episode here.?

Towards Budget-Based FX Hedging: A Fishy Story

Citing an FAO study, the Financial Times notes that "the amount of fish farmed globally just surpassed the wild catch. In 2022, 94.4m tonnes of fish were farmed in pens and ponds, vs 91.0m tonnes in open water."

The surge in aquaculture is bound to alter many a firm's pricing parameters. Just compare the prices of frozen and wild sea bass—it's a story of steady vs. dynamic prices. The upshot: FX hedging programs will need to be correspondingly adjusted.?

Kantox's álvaro Villar Silva comments: "With more predictability, budget-based FX hedging is likely to gain ground vs. hedging only firm commitments".

Five Useful Links

1. Abercrombie & Fitch. The Financial Times reports about the fashion company’s swift turnaround, as gross profit margins rose to 66.4% in Q1, vs. 61% in 2023 Q1. CFO Scott Lipesky adds: "Global growth is next for us". FX risk management will soon come into play, just as the firm reduces order time to improve inventory management.
2. Credit ratings. According to a Fitch Ratings analyst cited by the WSJ CFO Journal: "Once downgraded, it takes on average five years for companies to get back to investment grade”. The only U.S. airline with an investment-grade credit rating from the 3 leading agencies is Southwest Airlines, the hedging champion.
3. FX volatility indices. Paul Golden writes about FX volatility indices in Euromoney. He cites Kantox’s point of view: “While we do not advise paying excessive attention to FX volatility indices, corporate risk managers may use them as they set markups when constructing the budget rate used in pricing”.?
4. Learning-by-exporting. A paper by the central bank of Poland finds evidence in favour of the "learning-by-exporting" mechanism. A survey of more than 2,700 Polish firms shows that 52.7% of exporters are aware of automation possibilities, vs. 26.5% of non-exporters. The more complex the supply chain, the more the willingness to automate processes.
5. FX code of conduct. The Global Foreign Exchange Committee has updated its assessment of the FX Global Code review. Topics include: (1) The transition of securities settlement from T+2 to T+1 and its (limited) impact on FX markets; (2) The impact of further electronification of markets and the sophistication of trading strategies

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