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Managing your foreign exchange risks

Are you ready to deal with volatile currency values and their potential impact on your net income?

Canada is now the fifth-largest exporter of agricultural and agri-food products in the world. As an export-focused industry, Canadian farmers are regularly exposed to the often-volatile currency exchange market. And while exchange rates have always moved, the fact that we are now so closely linked to a global economy has heightened our exposure to the effect of global currency movements.

We are especially vulnerable to the movements of the U.S. dollar. Because it is a dominant currency for much of the world, its volatility is a key consideration for Canadian agri-businesses, especially those trading in the commodity markets. For this reason, hedging your currency risk can be an incredibly powerful tool in the arsenal of a successful farm.

Farms can be very susceptible to currency risks without the expertise or plans in place to manage the inevitable currency exposure tied to international payments. But, managing this risk might not be as hard as you think. With an understanding of where your farm is exposed to currency risk, a customized plan can help ensure currency fluctuations don’t keep you up at night. After all, managing your foreign exchange risk is not about making money, but about preventing losses that might have a negative impact on your profitability.

What influences exchange rates?

Generally, eight key factors cause market volatility, including:

  1. Political and economic conditions
  2. Rates of inflation or deflation
  3. Interest rates
  4. Monetary policies
  5. GDP
  6. Fiscal policies
  7. Commodity prices, particularly oil
  8. Unemployment rates

Looking back, 2017 was an incredibly busy year for the Canadian dollar which, of course, was very well placed against the U.S. dollar as its value soared. Monetary policy was a big driver in how the currencies moved over the last 12 months, with the U.S. Federal Reserve starting to pull away the stimulus that had been in place since the financial crisis while looking towards the White House and the new U.S. tax plan.

The labour market in Canada was also a key driver in the strength of the currency. Performance throughout December 2017 showed that the Canadian dollar has key upside potential against its U.S. counterpart. But it’s not just against the U.S. dollar where we’ve seen a strong performance. Due to the uncertainty surrounding Brexit, the Canadian dollar performed well against the pound until August when the pound started to show signs of life.

It’s a case in point: if you don’t have a crystal ball to know what’s going to happen and when, the smart decision is to actively manage your currency risk.

Establishing a plan to manage your risk

Identifying your exposure to currency volatility is the first step in ensuring that you are protected against forces outside of your control. If you’re setting prices for a product (likely at a predicated exchange rate) or purchasing a piece of equipment from an international supplier (likely budgeted at an anticipated exchange rate), you have currency exposure.

With each exposure to currency risk, establishing a plan to manage that risk can help ensure your transaction remains profitable. Even a one-cent change in the USD/CAD exchange rate can make or break a deal. Take for example, the Canadian jobs report released at the start of January 2018. This first major piece of data for the year caused fluctuations in currency rates, and saw the USD/CAD rate drop aggressively lower in the space of a few minutes after better than expected labour figures were announced. USD/CAD fell from 1.2500 to lows of 1.2350 — a move that would make a significant difference to any transaction’s profitability priced in U.S. dollars and requiring immediate payment.

Like the weather, plans can be developed to protect against unforeseen currency risks. Key is knowing you don’t have to manage them alone. Both banks and more personalized concierge-style foreign exchange providers can help. A partner that will get to know you and your business, and will design a solution that’s best for you is a good bet.

Regardless of which provider you choose, hedging your risk and locking in a forward contract is a valuable tool in protecting a contract’s profitability. This allows you to purchase or sell a predetermined amount of currency at a known rate within a specific time frame. It ensures you’re not relying on the need for a spot transaction, which might mean you’re forced to purchase or sell currency at a rate well above your budget. While the downside of establishing a forward contract means that you might not be able to take advantage of market ‘highs’, the certainty of knowing your exchange rate in advance can be critical in maintaining profitability.

Another strategy might include planning to execute a mix of both forward contracts and spots, allowing some flexibility in when you make an exchange. A foreign exchange specialist can help keep you in-the-know about current events and market movements, allowing you to act quickly and to time payments when a favourable market condition exists.

In addition to helping you establish a currency strategy that suits you, currency specialists will also ensure international payments are transferred to and from your bank accounts quickly and cost effectively. Whether by wire transfer or another form of electronic fund transfer, having an expert on your side to process these payments is a valuable asset.

So, what’s the bottom line? Canadian farms are no stranger to risk, but foreign exchange risk isn’t something that needs to keep you up at night. By establishing a plan in advance and using the help of currency specialists, you can feel more confident that this is one risk you can manage.

Dave Dominy is CEO of Firma Foreign Exchange, one of Canada’s leading foreign exchange and international payments firms. Firma currency specialists work with customers to simplify business across borders, reduce currency risk and make foreign exchange less complex. The company objective is to give business owners peace of mind that allows them to focus on what they do best — growing their companies.

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