The past few months have shown, not in a good way, how currencies can be impacted by external events. In this case, Covid-19, no one had an idea how quickly and how dramatically the virus would hit globally. It became a global crisis in a matter of weeks not months and the world’s economy basically came to a stop. Not just Canada and some other countries, but all countries, no country was spared.
What happened at beginning of the outbreak
Initially, oil prices dropped, commodity-based currencies such as the Canadian dollar weakened, but the exchange rates of key emerging countries were battered. Brazil’s, Mexico’s, South Africa’s and Turkey’s currencies suffered losses between the end of February to the middle of March that were crippling. If these currency levels were to remain, emerging market countries would have recessions not seen since the 1930s. What was happening is that these countries were experiencing huge capital outflows, that means international investors who had assets in these emerging countries were selling as quickly as they could and sending the funds back to their home countries or buying U.S. dollars. In order to buy USD international investors sold the local currencies at prices that were significantly lower, it’s like when everyone wants to leave at the same time and there is only one door to get out, you take what ever price you are given.
On the other side of these flows, advance economies, such as Germany, Britain, France, Japan and the U.S. received capital inflows, particularly the U.S. In times of economic stress this is called flight-to-quality or flight-to-liquidity, investors rebalance their portfolios from risky to conservative assets, usually government securities. The Canadian dollar subsequently rebounded with a couple of weeks as analysts realized that the currency was vastly oversold in relation to market conditions. An article published on May 5 2020 shows the GDP in emerging markets as illustrated below.
What do countries do when everyone is selling their currency?
When a country suffers a rapid outflow of foreign capital and depreciating currency, the country tends to rely on its Foreign Exchange Reserves (FX reserves) to slow down or stop the price depreciation by providing liquidity and some form of stability both domestic and international. The problem during this pandemic was not all countries had the same amount of FX reserves in order to combat their respective outflows. FX reserves are like a savings account held in different currencies other than their domestic currency. One country may hold billions in USD or Euros or Japanese yen, when the time is necessary, the central bank will sell these currencies to buy back its own domestic currency. This is called FX intervention and nearly all the central banks of the emerging counties were involved one way or the other. Some emerging central banks soon ran out of money but were able to arrange loans from the world’s advance economies such as Japan, Britain and the European Central Bank. In fact, the U.S. Federal Reserve allowed loans to countries that held U.S. Treasuries and used these as collateral.
Did it work?
As time progressed, markets globally started to stabilize, equities are now back to pre-Covid levels or even higher, currencies are also back to pre-Covid levels and the global economy is growing, however, it is not at pre-Covid levels as certain sectors have yet to reopen or have set at specific levels.
Restaurants can have only 50% capacity, hair salons, movie theaters are now just opening, these are just a few of the businesses that have been affected severely by the pandemic. Airlines are now examining passengers before getting on board the plane and are demanding that passengers wear masks as well. At the time of this article a leading pharmaceutical company has released a rapid Covid-19 test which will cost $5 and have a result within fifteen minutes.If effective this will allow the travel industry to open up more especially airlines. Countries will allow visitors that have been tested and may remove the self-isolation requirements. Currencies have also come back, some countries such as Argentina, Peru, Turkey, Indonesia had imposed regulated limits on buying foreign currencies, but these have been subsequently removed.
Governments have relaxed international transfers at the business to business level, however, they imposed further measures to ensure that their domestic banking systems are fully prepared should there be a second wave and possible economic shutdown.
The Currency Swings
On February 12th, 2020, the USDCAD was 1.3266, one month later at the height of the pandemic, it was 1.4500, and at the time of this writing its 1.3121 and you have to check the latest currency rates if you want to know what is the rates right now. Not only has it come back to pre-Covid levels, it’s actually stronger. It should be noted that it took five months to come back, and one month to go lower. USDCAD fluctuations from late June to September based on Gold Price data is illustrated below.
If one is in the import and/or export business, the past six months have been chaotic, and possibly the worst experience of their business career. This is where a good businessperson examines their budget, expectations of when to pay for or receive their foreign goods and use some form of hedging, such as forwards, options, or a combination of both. It mitigates some of the volatility such as this hopefully once in a lifetime economic downturn.