The exchange rate situation between the peso and other currencies is particularly uncertain today. The same happens with interest rates. On Wednesday, March 16, the Federal Reserve (Fed) of the United States raised its benchmark federal funds rate, the interest rate, by 25 basis points, from a range of 0%-0.25% to one of 0.25%-0.50%. . Likewise, the Bank of Mexico has already carried out several hikes in the interest rate, the most recent on March 24, when it raised it by 50 basis points to 6.5%. In fact, the Fed recently indicated that it expects to carry out another six hikes in the interest rate, which will also affect the monetary policy decisions of the Bank of Mexico.
The prospects for inflation and interest rates, the prospect of an uneven and slower recovery than expected until a few weeks ago, as well as the pandemic and Russia’s invasion of Ukraine, are sources of uncertainty and volatility in the exchange rate. These are always present, but today in particular there are volatile times ahead that could represent significant direct risks for companies, risks that can be mitigated through currency hedging.
Many types of companies are exposed to foreign exchange risk, although those that depend, in whole or in part, on transactions and financing in foreign currency stand out among them. For example, companies engaged in the import or export of goods and services are constantly exposed to sudden changes in the value of the currencies of the places where they operate. The same thing happens to companies whose inputs, or part of them, come from abroad, since their costs run the risk of skyrocketing if they suddenly have to pay more pesos for the same inputs. Finally, those companies that have debt in foreign currencies can suffer major setbacks if their debts suddenly increase unexpectedly.
A hedge can eliminate a significant portion of the currency risk for these companies. Foreign exchange hedges are insurance through which a company can guarantee a certain exchange rate, thus avoiding undesirable surprises. By hedging, a company can also eliminate risk but maintain its profit potential; An exporter who charges in dollars can guarantee a minimum exchange rate so as not to lose if the dollar falls, but maintain his profit potential if the dollar rises and can charge more pesos for his products.
In general, currency hedges are a very useful instrument for companies, but in these particularly uncertain and volatile times, they become a key tool to prevent unnecessary risks and stay ahead of their competitors.
In uncertain and interconnected times in which we live, unforeseen events in distant places, such as Russia’s invasion of Ukraine, can generate significant volatility for the peso and affect the business of companies that use foreign currency, so it is important to know when it is convenient to have coverage.
*The author is executive director of Grupo Financiero Base.