Hedging Strategies For Year-End

December 8, 2022, by Michael Buck

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.

Let's delve into the analysis for the following three markets:

UK Case Study

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.

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.

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.

US Case Study

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.

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.

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.

Australia Case Study

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.

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.

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.

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About the Author:

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.

About GPS Capital Markets, LLC:
Headquartered in Salt Lake City, Utah, GPS Capital Markets, LLC provides corporate foreign exchange services that help companies manage their foreign currency risk and execute foreign currency transactions. Founded in 2002, GPS brings together a senior management team rich in international banking experience from the world's leading financial institutions. GPS has several offices throughout the United States, as well as in Australia, Canada, the European Union and the United Kingdom. It combines competitive exchange rates with a host of tailored international financial solutions for its clients. For more information, visit www.gpsfx.com and follow @gpscapitalmarkets.

Press Contact:
GPS Capital Markets
Lindsey Wing
801-979-6114
lwing@gpsfx.com