Currency management is often deprioritised in businesses, taken seriously only after a crisis hits.
However, unmanaged currency volatility is one of the greatest threats to corporate profitability, capable of wiping out hard-earned margins in the blink of an eye.
The landscape in which Foreign Exchange (FX) markets function in are changing.
We are moving away from an era defined by predictable, slow-moving economic fundamentals and into one that is driven by geopolitical shock events – which only further escalates the financial risk to businesses.
Unlike traditional economic indicators that build momentum over months, geopolitical tensions surface seamlessly out of nowhere, sparking immediate volatility and creating complex ripple effects across global markets.
From this, we are witnessing economic markets that are taking a battering โ world-wide rapid repricing, strained supply chains, and inflation increasing on a global scale.
Why the market reacts more violently today
One might ask why currency markets seem more sensitive now than in previous decades. The answer lies in a combination of technological and societal factors.
- Digital amplification
Digital and social media is accelerating market narratives. Their cyclical and always-on nature means that information is shared constantly, and market dynamics are the most accessible they have ever been. Compared to a few decades ago, where the information shared wasnโt always up to date, this new environment turns the old “buy the rumour, sell the fact” phrase into a self-fulfilling prophecy, deepening market swings.
- AI
Artificial Intelligence has impacted many industries for better and for worse. For currency markets, it has quickly become an integral part of how certain functions within the sector are performed and has brought with it real advantages. However, AI-driven trading signals are increasingly making decisions based on patterns, headlines, and market behaviour. In an era where uncertainty is the new normal this causes negative effects, worsens industry reactions and reinforces short-term momentum.
- Algorithmic trading
Algorithmic trading can exaggerate price movements. When stop-loss orders are triggered at scale, the resulting volatility is far more intense than historical norms.
- The state of geopolitics
The reality is that we are living and operating in an increasingly unpredictable climate, and this has a significant impact.
The conflict in Ukraine laid bare our hidden reliance on specific supply chains, fuelling global food inflation. More recently, weโve been dealing with scenarios we once thought impossible. Take the blockades of vital waterways, such as The Strait of Hormuz, or even the threat of buying or invading a country.
Further to this, Trumpโs erratic trade policies involving tariffs and sanctions, and the games of tennis between himself and The Supreme Court, have all played a part in destabilising capital flows and pricing structures globally.
FX markets are simply unprepared for this amount of global uncertainty.
Why the market is permanently wounded
Geopolitical impacts are rarely short-lived. We can see this from the sterlingโs biggest influence โ Brexit.
A decade later, and the sterling still trades at roughly ten percent differential compared to pre-referendum levels, weighed down by persistent questions over trade and labour shortages.
Similarly, while the rhetoric of the Trump administration caused immediate market tremors, it could also trigger a longer-term shift. This is something weโre already bearing witness to, with markets starting to push back on their US reliance, a clear sign that the market is beginning to stand up against perceived instability.
How this implicates currency
These rising geopolitical tensions have reignited the debate over the US dollar’s status as the world’s primary reserve currency. Indeed, if hostilities from the US continue, we could see significant changes to the global financial system towards the end of the 2020โs:
- The euro could become the main benefactor as a diversification anchor.
- The Swiss franc could establish itself as a โsafe havenโ currency.
- Sterling could be part of a broader reserve basket.
- The old, traditional values of world reserve currency may even be upended, considering Xi Jinpingโs recent calls for Chinaโs renminbi to attain global reserve currency status.
Managing FX risk during elevated Geopolitical tension
Companies with high FX exposure are most vulnerable. This includes UK importers and exporters who are facing potential tariffs, leading to huge price changes and margin pressure. In our experience, weโve found that businesses with high foreign currency turnover are more at risk to emotional decision making and panic hedging when faced with elevated geopolitical tension.
No one can actually predict the FX market, but there are ways for businesses to protect the bottom line – strategy over sentiment.
A robust FX strategy shouldnโt fluctuate with the headlines, which as weโve established, come in hard and fast. Instead, it must be anchored in business fundamentals and provide investors and companies with governance and guidance. Adhering to strict guidelines provides stability and protects against uncertainty. This is especially vital for SMEs, who often lack the deep cash reserves that larger corporations use to weather economic storms.
At Lumon, we advocate for a layered approach when operating during times of elevated geopolitical tensions.
- Avoid timing the market โ consider smaller, regular hedges over time to ensure a level of stability. Quarterly layering gives businesses blended FX rates that reduce timing risk.
- Remove emotion โ by following a repeatable, disciplined framework, businesses can ignore the noise of the news cycle.
Effective FX risk management isn’t about having a crystal ball to predict the next geopolitical crisis. Itโs about building a robust framework that is designed to absorb the shock when it inevitably arrives.
Learn more about Lumonโs foreign exchange and currency risk management service, and explore the possibilities available to you.
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