The FX factor – that is, the economic impact of foreign currency exchange rates – is increasingly relevant not only to nominal GDP outcomes in The New Neutral global macro environment (for details, see Part I of this blog series), but also to the microeconomic side. For many corporations, FX volatility is shaking up their business landscape.
As the corporate world becomes more global and more integrated, the share of revenues and profits corporations generate outside their home country or home currency is trending higher (while there are important differences across countries and sectors – see first chart). This leaves corporations exposed to FX volatility – and more exposed than what trade or GDP data might lead us to believe, because large parts of these overseas revenues are fully generated abroad (manufactured and consumed) and therefore do not enter the home country’s trade data or GDP.
Corporations not only have to contend with potential revenue volatility due to the FX factor: It could also affect their debt and leverage, as some may have substantial amounts of foreign-currency-denominated debt (see second chart).
Finally, we are also seeing an increase in the number of semi-floating or freely floating currencies, the Chinese yuan being the latest example. Debt and earnings in these currencies are subject to FX fluctuations.
In summary, corporations are significantly exposed to FX volatility via their revenues and debt at a time when world GDP is itself disproportionally feeling the effects of the FX factor. And if the FX factor has a significant impact on corporate earnings and leverage ratios, then it may in turn affect the performance of the securities issued by these corporations. In this way, the micro can influence the macro as the FX factor may have an indirect impact on the wealth effect and financial conditions.
This business-based, micro perspective offers another view into why FX in The New Neutral is an endogenous factor influencing the financial system – a factor to be taken seriously, indeed.