Year-End FX Hedging: Maximize Your Financial Stability

|
639281748df82b209bd272de YE20Hedging20Strategies20Blog

As the year-end approaches, foreign exchange markets in 2022 have reinforced the need to practice solid risk management. It is easy to get distracted by the season at this time of year, but our analysis shows that markets still move and should be treated the same as any other time of the year. In this research piece, GPS Capital Markets analyzed seasonal trends for the currency pairs of UK, US, and Australia’s major trading partners for the years ranging between 2017 to 2021.

In each instance, the currencies experience wide market ranges during the analyzed periods, suggesting it is in a company’s best interest to have an FX hedging strategy that addresses risk.

Spot Movements on a Seasonal Basis

In the charts below, GPS analyzed the percentage movement of the currency pairs (GBP/USD, GBP/CNH, GBP/EUR) from December 10 to January 10, in the years ranging from 2017 to 2021. To make the movement easier to compare, the charts show percentage movement using December 10th as a base in each year. Each line in the chart below is a separate year.

In the chart below, we can see that over that period GBP/USD decreased by 0.70% in 2019/20, and yet increased 2.29% last year and by 2.05% in 2020/21.

63911b9cf8b66ef5076f7d38 Year20End20Hedging20GPB20USD final
639266381c9d2a8fc7c5dd80 Year20End20Hedging20GPB20CNH final
63926709dea4b306a5d5ddee Year20End20Hedging20GPB20EUR final

Market Volatility in Previous Years

In the previous sections we looked at the pure spot movement. GBP volatility has been heightened for a time due to factors such as trade negotiations, but what we have observed in other currencies such as EUR/USD, USD/JPY, USD/CNH, USD/CAD, and AUD/USD is that the current level of volatility is much higher than previous years. The charts below show the level of the 1-month EUR/USD implied volatility and each line represents a different year. The bold blue line at the top shows the current year.

Implied volatility for EUR/USD this year is trading at 10.59% and the average for the previous five years was only 5.69%. In practical terms, this means the market is expecting wider ranges than it did previously.

6392673b80481a996b791aa0 Volatility20EUR20USD20 20Final

Conclusion

This research piece is not designed to predict where the currencies will go between now and the beginning of 2023. The research shows that the spot market does move between the early December to early January periods. With the expected wide market ranges derived from the options market, it would be good practice to have risk covered over this period.

Spot Movements on a Seasonal Basis

In the charts below, GPS analyzed the percentage movement of the currency pairs (USD/JPY, USD/CNH, EUR/USD, USD/MXN, USD/CAD) over the period of December 10 to January 10. To make the movement easier to compare, the charts show percentage movement using December 10th as a base in each year ranging between 2017 and 2021. Each line in the chart below is a separate year.

In the chart below, we can see that over that period USD/JPY decreased by 4.32% in 2018/19, by 1.87% in 2017/18 and yet increased 1.55% last year.

639268faa527278e27137feb Year20End20Hedging20USD20JPY20 20final
63926911bb506d3639e14c88 Year20End20Hedging20USD20CNH20 20final
63926920b7cebd108a75ad0f Year20End20Hedging20EUR20USD 20final
6392694fd85d6f477b37b227 Year20End20Hedging20USD20MNX2020 20final
6392695cbf78e10a7d1b8e67 Year20End20Hedging20USD20CAD20 20final

Market Volatility Is Higher than In Previous Years

In the previous sections we looked at the pure spot movement. There is one key factor which makes this year different to the past five periods. The charts below show the level of the 1-month USD/JPY implied volatility and each line represents a different year. The bold blue line at the top shows the current year.

Implied volatility for USD/JPY this year is trading at 13.8% and the average for the previous five years was only 5.9%. In practical terms, this means the market is expecting wider ranges than it did previously. This differential is also applicable to USD/CNH, EUR/USD and to USD/CAD.

6392699f9462161057968f01 Volatility20USD20JPY20 20final
639269afc3d12c14215a90b2 Volatility20USD20CNH20 20final
6392673b80481a996b791aa0 Volatility20EUR20USD20 20Final
63926a288c05da2862657298 Volatility20USD20CAD20 20final

Conclusion

This research piece is not designed to predict where the currencies will go between now and the beginning of 2023. The research shows that the spot market does move between the early December to early January periods. With the expected wider market ranges derived from the options market, it would be good practice to have risk covered over this period.

Spot Movements on a Seasonal Basis

In the charts below, GPS analyzed the percentage movement of the currency pairs (AUD/USD, AUD/EUR, AUD/CNH, AUD/GBP, AUD/NZD) from December 10 to January 10. To make the movement easier to compare, the charts show percentage movement using December 10th as a base in each year, for the years ranging between 2017 to 2021. Each line in the chart below is a separate year.

In the chart below, we can see that over that period, AUD/USD increased by 4.21% in 2017/18 and 2.95% last year. The moves can also be seen to not be in one direction, with 2018/19 falling almost 3% before finishing close to flat.

63926ad9d06252717c594718 Year20End20Hedging20AUD20USD20 20final
63926ae9f294978f160c0db5 Year20End20Hedging20AUD20EUR20 20final
63926af9817c6279c25daa91 Year20End20Hedging20AUD20CNH20 20final
63926b09c3e4fc36cc5d6740 Year20End20Hedging20AUD20GBP20 20final
63926b19a52727a2e813c740 Year20End20Hedging20AUD20NZD20 20final

Market Volatility is higher than previous years

In the previous sections we looked at the pure spot movement. There is one key factor which makes this year different to the past five periods. The chart below shows the level of the 1-month AUD/USD implied volatility and each line represents a different year. The bold blue line at the top shows the current year.

Implied volatility this year is trading at 13.7% and the average for the previous five years was only 7.5%. In practical terms, this means the market is expecting wider ranges than it did previously. This is the same for all the AUD cross rates.

63926b2f4677a66823892959 Volatility20AUD20USD20 20final

Conclusion

This research piece is not designed to predict where the currencies will go between now and the beginning of 2023. The research shows that the spot market does move between the early December to early January periods. With the expected wider market ranges derived from the options market, it would be good practice to have risk covered over this period.

Subscribe to our FXbeacon LinkedIn newsletter and follow us on LinkedIn for up-to-date FX news from around the world.
Help us spread the word

About Michael Buck

author-headshot

Michael Buck is part of GPS’ trade desk in Perth, Australia. He has worked in foreign exchange specializing in derivatives in London, New York and Australia. He has been both a trader at bank and has developed pricing and risk software solutions.