Recent market volatility is a reminder that risk is always around the corner. For businesses and investors with foreign currency exposure, more than ever managing risk is especially prudent.  

We recently hosted an event to provide insights into the current macroeconomic and foreign exchange (FX) landscape. Michael Gregory, BMO Economics’ Deputy Chief Economist, discussed the impact of U.S. tariffs on the economic landscape, particularly on the U.S. dollar; and Sheralyn Mills, BMO Capital Markets’ Managing Director, FX Options Structuring, delivered an overview of currency hedging strategies. 

Following is a summary of their presentations. 

A federal appeals court recently ruled against President Donald Trump’s use of the International Emergency Economic Powers Act (IEEPA) to impose sweeping tariffs on imported goods. The Supreme Court has agreed to examine the White House’s appeal. Even if the lower court’s decision is upheld, Gregory said Trump is likely to fall back on the powers he does have, such as levies imposed in the name of national security threats under Section 232 of the Trade Expansion Act of 1962. 

“Tariffs are here to stay. They are not going away,” Gregory said.  

The weakness of the U.S. dollar in the face of these tariffs has been unexpected. “The U.S. has a large trade deficit, and when you have a big deficit, that creates downward pressure on the U.S. dollar, other things being equal,” Gregory explained. “If you implement tariffs, which lowers the deficit, that's less selling pressure on the U.S. dollar. Therefore, the dollar should rise broadly against the basket of global currencies. Of course, we've seen the opposite.” 

Uncertainty about what the tariff policies would be, and what impact they would have on the economy, has been a factor. Gregory also pointed to uncertainty regarding fiscal and other policy areas as well.  

“Tax cuts and deregulation are positive for economic growth, but deregulation and tariffs are not so positive for growth,” Gregory said. “Massive spending cuts are also not so positive for economic growth. We have this tug of war going on. So even as we get a sense of what these policies are looking like, their economic impacts remain a source of uncertainty.”  

Gregory also pointed to a dynamic of the U.S. economy. As the federal deficit has continued to grow, U.S. households have been spending more while saving less.  

“The net result is that you have a shortage of savings in the economy, and you need to attract foreign investment to offset that,” Gregory said. “And whenever there is hesitancy in that foreign investment, asset prices tend to change. Stock markets weaken... and the U.S. dollar weakens. So, while tariffs are positive for the dollar, the uncertainty around policy and the hesitancy of these capital inflows into the U.S. slowed down. Ultimately, that is what’s contributing to weakness in the U.S. dollar.” 

An additional risk for the U.S. dollar is that other central banks have been aggressively cutting interest rates while the Federal Reserve has been on hold and may just be about to start a series of rate cuts.   

The U.S. dollar significantly weakened in the immediate aftermath of the announcement of sweeping tariffs in April. Given that the dollar has continued to slump, managing currency risk is currently top of mind for companies with foreign currency exposures. 

“The bottom line is that predicting currencies is tricky,” Mills said. “One thing we know for sure is that a move is inevitable. Most companies don't have the luxury of being able to pass on adverse changes in foreign exchange to their suppliers or customers, so hedging makes sense to smooth the impact of any FX moves over time.”  

While there are several strategies that use various methods for forecasting currencies, Mills emphasized that there’s no one-size-fits-all approach. Instead, companies need a clearly defined hedging policy tailored to their overall strategy and risk tolerance. She said the policy should incorporate five elements: 

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  Setting goals and objectives 

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  Identifying and quantifying risk 

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  Establishing hedging guidelines and policies 

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  Strategy development 

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  Consistent monitoring 

Mills said your hedging strategy could be based on specific goals such as reducing earnings volatility. From there, you’ll also need to identify FX risks by currency, the type of exposure and the term of your holdings. Conducting a sensitivity analysis can help you establish your acceptable risk tolerances. After determining these and other factors, including regulatory and accounting considerations, you can decide on your optimal mix of hedging strategies. 

“The best practices come from treasury teams who are dynamically empowered to operate within a policy so that when an outsized event happens, they’re prepared for it,” Mills said. “And there needs to be continuous monitoring to determine what worked and what didn't, and then adjust accordingly. If you analyze the effectiveness of your hedging and you're kept informed, then you're going to be best positioned to react when we see big currency moves.” 

Mills emphasized that FX hedging isn’t necessarily a one-and-done strategy; companies can tweak their hedges based on their needs and objectives. But it’s a complex undertaking, which is why working with an FX hedging expert can be a great resource.  

“Currencies are unpredictable,” she said. “Volatility, like we saw in April, can significantly impact things, and having a well-defined hedging policy certainly helps. The more information we have, and we work with you to get that information, the more we can tailor a strategy that is going to work specifically for you.”