Why Foreign Exchange Markets Matter to Global Business

 

Currencies around the world have experienced substantial volatility since the financial crash of 2008. The ongoing turmoil in Greece has caused the Euro to remain on a downward spiral. As the Eurozone fights to maintain value and foreign confidence in its currency, the U.S. dollar has shown considerable growth, especially within the past year. Yet in some ways, this development is a double-edged sword. While a rising dollar is representative of an economic comeback in the wake of the great recession, it hurts the profitability of some businesses operating on a global scale. On July 22, American Express Co. reported a 3.7 percent fall in its second-quarter earnings, causing a 1.4 percent drop in its shares. The company attributed below-expected revenue to struggles in international operations, a department directly hit by the strong dollar.

When the dollar is on the upswing, U.S. domestic products and services become relatively more expensive and less competitive to international customers. Companies across industries, from consumer products giant Procter & Gamble Co. to technology industry leader Microsoft Corp., are losing traction in the marketplace and experiencing subsequent revenue dips. Historically, this is not a surprising outcome. According to a story in TIME magazine, the five major declines in corporate profitability since 1970 all occurred following periods of relative dollar strength. But companies in today’s globalized economy are more reliant than ever on foreign consumption. The slightest fluctuations in exchange rates can immensely impact not only corporate profitability, but also labor markets, capital flows and interest rates.

Why are foreign exchange (FX) markets inherently volatile?  Price changes due to shifts in supply and demand, changing political dynamics, economic cycles and even the weather can influence the flow of currency around the world. A recent Wall Street Journal  article showed that currencies in oil-exporting countries such as Norway, Canada, and Russia have weakened with the plunge in crude prices.

There exists a growing need to hedge against inevitable variations in exchange rates as economies become increasingly integrated across borders. A new video by Futures Fundamentals, CME Group’s education site, explains how FX futures contracts can control for some amount of this risk.

Check out the full Futures Fundamentals site for more videos and graphics on futures markets.

Mackenzie Rech is a Communications Intern at CME Group and a student at Lawrence University where she studies economics and english.

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