Global uncertainty and the international payments landscape

By Mike McTavish | 5 April 2017

With economic and political uncertainty continuing on a global scale following the UK’s vote to leave the European Union and subsequently Article 50 being triggered, alongside the election of President Trump and the changing political landscape in Europe, the resulting impact on the international payments landscape has been significant, and it appears that things are unlikely to calm down anytime soon.

Although Article 50 has now been triggered, we have to wait until April 29th for the next important instalment, when the EU’s 27 leaders will meet to agree their negotiating lines (plan of attack) in the Brexit talks. In reality, it will be May before the nitty gritty debate starts. 

The timing for Britain to leave the EU will change with every legal and regulative challenge the process incurs (and there will be many). The two year timetable inserted in Article 50 is probably somewhat unrealistic due to the various trade deals that will need to be negotiated between Britain’s 27 counterparts, bearing in mind that each will have a veto over the conditions.

Scottish First Minister Nicola Sturgeon, meanwhile, has called for a second independence referendum (Indyref2) before the final Brexit deal; a move rejected by the PM. 

Data wise, the UK has outperformed continental Europe almost uninterruptedly since the onset of the Euro crisis in 2011, but the UK is now underperforming slightly on the PMI measure. The Eurozone manufacturing PMI in February was 0.9 points higher than in the UK, and the services index was 1.7 points higher. Early March estimates look very similar.

There are two possible explanations: Firstly, with a delay, the EU referendum result is starting to have the originally expected effect, and secondly, the UK has a more mature cycle which is approaching its end, and growth would have slowed relative to the Eurozone anyway. The verdict is open. What seems certain is that rising inflation in 2017 will hit the UK more than continental Europe, largely due to weak Sterling and the fact that the UK has a greater reliance on consumer spending for growth.

What about GBP/EUR currency rates? Since the beginning of 2017, GBP/EUR has been bouncing within the 1.13-1.1910 range. Political uncertainty is the key risk in the coming months. For the Euro side, German, possible Italian, and more importantly French elections will be in focus for the market. For Sterling, the progression of negotiations with Europe around the UK’s exit from the bloc will be influential in determining how the currency performs.

The difficulty in quantifying these risks, and the significant degree of uncertainty surrounding these events, is well reflected among forecasters, who currently show a high level of divergence in their expectations for GBP/EUR at year-end (lowest: 1.00 or parity as we call it and highs of 1.30). In terms of monetary policy, the Bank of England (BoE) and European Central Bank (ECB) look set to maintain their current stances through the remainder of 2017, although recent hints from both central banks suggest tightening could occur ahead of the current market implied expectations.

Over the Atlantic, the Federal Reserve Open Market Committee (FOMC) pushed ahead with the second rate increase in three months. The move was widely expected following strong signals from Fed members and positive economic data, and the attention has quickly turned to how many rate hikes to expect this year (and beyond). Having sent a dovish message in their statement, counter to market expectations many analysts still think three hikes this year are likely. But the Fed doesn’t feel the need to push markets on that theme until we’re closer to June. With the USD, that’s not necessarily negative but there is no real reason to buy USD right now based on that particular reason.

U.S. Data supports hikes in rates with the key Non-Farm Payroll release in February coming in at 235K, exceeding expectations. The unemployment rate fell to 4.7% and average hourly earnings moved to 2.8% (y/y). CPI Inflation is also on the up with a stellar 2.7% (y/y) in February. For the time being, consumer spending and housing stats are running in positive territory.

Let’s not forget about the fiscal side of things. The market is so negative in terms of what the Trump administration is expected to accomplish. Last month’s ‘litmus test’ saw US President Trump and House Speaker Ryan fail in their bid to pass a new healthcare bill. Markets are extrapolating failure at this juncture as a critical blow for the rest of the administration’s policy agenda. Why? It suggests the administration will not be able to accomplish much, particularly in regards to any kind of fiscal reform and thus the uncertainty could well weigh on the Dollar.

It comes as no surprise that due to these movements, USD cross rates are also experiencing heavy fluctuations. The U.S. Dollar has been generally weaker versus the Euro. Influenced by the outcome of the Dutch general election and speculation around higher ECB policy rates have pushed EUR/USD close to its year-to-date high around 1.0850 (at time of writing). However, as aforementioned, European politics is likely to remain a key source of downside risk for the Euro with elections in France and Germany later this year, arguably representing more notable flashpoints over the coming months.

GBP/USD has been seesaw trading since the start of the year between 1.1986 and 1.2698. This theme looks set to continue as we are in uncertain times, almost the perfect storm for currency markets. Again, the disparity in forecasts are sizeable with a low of 1.1300 and a high of 1.3253 showing for the next three months.

So what do all these major political, Central Bank and economic announcements mean for the international payments landscape?

Thousands of UK businesses of all shapes and sizes that transfer money overseas have likely been heavily affected already, and as previously iterated, the constant fluctuations in exchange rates is where these businesses will have been affected the most. The UK’s future relationship and trade terms with the EU and rest of the world are yet to be decided and this volatility is unlikely to cease anytime soon.

With this in mind, it is vital for UK businesses to have strong control over their international payments and cash management processes. This will enable each business better understand how much money they are transferring overseas at any given moment and will also help to reduce any unnecessary errors and delays in moving money across borders.

One of the most efficient ways businesses can fight against such widespread market volatility and changing FX rates is through the optimisation of forward contracts. If any business is either currently or in the process of looking to operate across borders and is required to cut the risks associated with currency fluctuations, then forward contracts are a preferred tool. Forward contracts allow businesses to lock in exchange rates, ensuring that they can make business payments at a pre-agreed rate of exchange in the future. This therefore protects profit margins against negative market movements, avoiding currency losses.

A forward contract is also an opportunity to secure a long term preferential rate and is an agreement to buy or sell a set amount of foreign currency at an agreed rate in the future. It can be argued in terms of how far into the future a business should set its FX rates - be it three, six or twelve months. From our experience, most forward contracts are set for a period of six months, which enables firms to regularly review their chosen FX rates and creates the opportunity to alter these if needed.

In terms of further flexibility presented by the use of forward contracts, businesses can look to make the most of ‘open forward’ type contracts. These enable each business to have a window of time during which the contract must be completed and therefore enables them to draw down individual amounts as and when required throughout the length of the forward agreement. This type of forward contract are particularly useful when a firm’s payment schedules and/or currency requirements are not repeatable on the same date each month, which of course, happens frequently.

In short, despite the unchartered territory we’re entering now that Article 50 has been triggered, the requirement for international payments will not disappear. With this in mind, it is vital for businesses that transfer money overseas to brace themselves for as many outcomes as possible and prepare as best they can for a smooth ride.

For further insights from market experts, contact Equiniti International Payments via eqipdesk@equiniti.com

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