EuroFinance

The Latin American financial landscape is undergoing a significant transformation. With the U.S. economy proving more resilient than anticipated and the Federal Reserve committed to maintaining higher interest rates for an extended period, central banks and corporations across Latin America are being forced to reassess their currency risk management strategies. In this environment of heightened volatility and uncertainty, there is a renewed focus on navigating the complexities of foreign exchange (FX) trading, managing risks, and leveraging technology to enhance financial operations. 

At the 2024 EuroFinance Global Treasury Americas conference in Miami, experts shared their perspectives on the evolving strategies being adopted to balance intra-regional FX trading in local currencies with traditional dollar trading, the varying risk tolerances guiding their decisions, and the strategic implementation of hedging practices.

Resilience of the U.S. economy and its impact on Latin America

Robert Wood, Principal economist, financial risk manager Latin America and the Caribbean at the Economist Intelligence Unit (EIU), discussed the surprising resilience of the U.S. economy and its implications for Latin American markets. “The U.S. economy proved to be much more resilient than we thought, putting pressure on the Latin American region and other emerging markets,” Wood explained. This unexpected strength has complicated the efforts of Latin American central banks, many of which had hoped to begin easing interest rates more aggressively.

Initially, Latin American central banks appeared to be ahead of the curve, having started their rate hikes earlier than the U.S. Federal Reserve. “They started hiking much earlier than the Fed and got on top of inflation at an earlier stage, allowing them to start easing interest rates already,” Wood said. However, the Fed’s decision to maintain higher interest rates for longer has delayed the expected easing cycle across the region. 

In the recent July meeting, the Federal Reserve maintained the interest rates at 5.25% to 5.50%, the highest level in 23 years. Jerome Powell, Chair of the Federal Reserve, noted that economic activity continues to expand solidly, with moderate job gains and a low unemployment rate. Although inflation has eased somewhat, it remains elevated, with some progress made toward the 2% target. 

According to Wood, the Federal Reserve could cut rates as early as September this year, with the potential for additional cuts over the next 18 months. This shift could eventually weaken the U.S. dollar and provide some relief to Latin American currencies, but for now, the region remains under pressure.

Strategic hedging in a volatile environment

In response to these challenges, industry leaders in Latin America are re-evaluating their approaches to hedging. Pamela Potrie, Latam finance senior director at PedidosYa, an online food ordering and delivery Company and a subsidiary of Delivery Hero, shared insights into the unique difficulties faced by companies operating in high-volatility markets like Argentina. “With revenue coming from Argentina, where liquidity is reduced and volatility is high, hedging becomes expensive,” Potrie explained. The high cost of hedging in such markets forces companies to carefully weigh the benefits against the potential drawbacks.

Potrie emphasised the importance of understanding the maturity of a company’s finance function before implementing a hedging strategy. “Forecasting cash flows is a prerequisite to any successful hedging strategy,” she noted, pointing out that natural hedges, such as local currency operations, can help mitigate risk. Additionally, companies like PedidosYa are exploring innovative approaches, such as negotiating local currency invoices from global large suppliers, to manage exposure more effectively. “We recently negotiated with one of our suppliers in Argentina to invoice us in local currency, which helps us manage our exposure,” Potrie said.

Ciaran Fegan, Senior director, FX risk management and strategic projects at Viatris, a global healthcare company, offered a broader perspective on managing FX risk in the region. Fegan described Viatris’ multi-tiered hedging programs, which include cash flow hedging, net investment hedging, and balance sheet hedging. These programs are designed to reduce the impact of FX volatility on the company’s revenue and foreign subsidiaries while also taking advantage of market opportunities. “We’ve implemented tech solutions that integrate directly into our ERP systems, allowing us to consolidate and analyse exposure data by market and currency,” Fegan explained. This approach enables Viatris to effectively manage exposure in both developed and less liquid markets across Latin America.

Both Potrie and Fegan stressed the importance of conducting a thorough cost-benefit analysis when considering hedging strategies in volatile markets. “In some cases, like Argentina, the cost of hedging can be prohibitively high,” Fegan noted. In such environments, companies must carefully consider whether the economic benefits of hedging outweigh the costs. “The success of a hedge should be measured by its ability to limit risk, rather than by whether it generates a profit,” Potrie added.

For companies operating in markets with high hedging costs, reducing balance sheet exposure can be a crucial first step. “One way to manage risk is by accelerating payments out of high-volatility markets,” Fegan suggested. By minimising exposure in these markets, companies can reduce the need for costly hedging strategies and focus on more efficient ways to manage risk.

The role of cryptocurrency in FX risk management

As Latin American companies explore new ways to manage currency risk both Potrie and Fegan expressed caution about using cryptocurrencies for hedging, they acknowledged its potential in specific scenarios.  “We’re exploring the potential of crypto for lower transaction costs in markets with broken financial systems, such as Argentina and Venezuela,” Potrie said.  “I think there’s definitely a strong case for studying the use of crypto to lower transaction costs in markets with broken financial systems, such as Argentina and Venezuela,” she added

Fegan, however, cautioned against substituting traditional FX exposure for crypto volatility. “Stablecoins and blockchain technology are interesting, but the concept of substituting an FX exposure for a crypto exposure that you may not fully understand may not be a great strategy,” he cautioned. Despite the potential benefits, both experts agreed that companies should proceed carefully and thoroughly evaluate the risks before incorporating cryptocurrency into their FX risk management strategies.

The importance of strong banking partnerships

In managing FX risk, the importance of strong banking partnerships cannot be overstated. Fegan emphasised that banking partners are crucial not only for providing liquidity but also for offering insights and ideas that can help companies navigate complex markets. “Your banking partners are fundamental, not just for liquidity support but also for idea generation and market insights,” he said. Strong relationships with banks can provide companies with access to essential markets when others may be unable to support their clients, especially during times of crisis.

Fegan also highlighted the role of banking partners in helping companies’ access new markets and manage risks more effectively. “Having close relationships with banks can be critical in gaining access to certain markets and executing hedging strategies when conditions become challenging,” he explained. By leveraging the expertise and resources of their banking partners, companies can better navigate the complexities of currency risk in Latin America.

Adapting to an uncertain future

As Latin America continues to navigate the uncertain economic landscape of 2024 and beyond, the region’s financial leaders must remain adaptable and proactive in managing currency risk. The resilience of the U.S. economy, shifting interest rates, and evolving financial technologies will all play a role in shaping the future of FX risk management in the region. By carefully weighing the costs and benefits of hedging, exploring new tools like cryptocurrency, and fostering strong relationships with banking partners, Latin American companies can better position themselves to thrive in an increasingly complex global economy.