Friday's sharp rise in the euro, coming after months of low volatility in currency markets, could have caught some European companies off guard and may prompt them to reassess how they hedge their foreign exchange risk.
European companies earning income from exports or other foreign operations may have to alter their trading strategies to prevent these earnings being eroded by the euro trading at such lofty levels, and potentially going higher.
Until recently, relatively high US interest rates and a fairly stable exchange rate have made it more expensive for European corporations to hedge - or insure - their dollar earnings against any falls in the US currency.
But that calm was shattered this week. The euro shot up through the psychological $1.30 level on Friday, breaking out of the broad $1.24-$1.29 range which had prevailed since May and rising to a 19-month high of $1.3109.
"As it's expensive to hedge the dollar because of interest rates being higher in the US than in Europe and with the market going nowhere, I think there has probably been a default to under-hedge dollar exposure," said Chris Turner, head of FX strategy at ING.
"Today may provide a wake up call to many that there are dollar risks into 2007 and they may want to raise their dollar hedge ratios a little bit," he added.
Frederic Jeanperrin, head of European corporate FX sales at Societe Generale, said that companies who have occasional or irregular dollar revenues have reduced their hedging in recent months. But those with regular flows may have also chosen to hedge at the lower end of their guidelines, he added.
However, in deciding to hedge their future revenues at the current unfavourable euro/dollar rate, European corporates need to be sure that this is not just a brief year-end move.
Not all currency analysts are convinced the euro's rally will last. They say the current move is not really fuelled by a concrete fundamental reason, and could have been accentuated by thin volumes in the wake of Thursday's public holidays in the United States and Japan.
"What is going to be very interesting to watch is...how are clients going to react. The question is: do you sit and wait and bear the pain? Or do you hedge at these levels," said Jeanperrin at SG.
"It's going to be very tough to make decisions." US interest rates, at 5.25 percent, are 200 basis points above those of the euro zone. That yield differential is factored into the price of currency forward contracts, so European corporates who hedge their dollar exposure by essentially selling dollars on the forward market are not getting as good a rate as they would do if US rates were lower.
From a currency market point of view, if corporates decide to hedge more of their dollar exposure by effectively selling more dollars, that could push the euro even higher.
"I'd like to think that this is a start of a decent move in the dollar, maybe to $1.34-35 (per euro)," said Turner at ING. Gernot Nerb, economist at Germany's Ifo Institute, said this week German exporters can live with the euro at current levels around $1.30 but would suffer if it went above $1.35.
A stronger euro makes euro zone goods less competitive on international markets. However Martin O'Donovan, assistant director, policy and technicals, at the Association of Corporate Treasurers said that companies were unlikely to have left themselves too open to sharp moves in currencies, even given the low volatility.
"Volatility as much as anything is what makes people nervous and given that things have not been that volatile for a long time, perhaps people got a little bit blaze about the need for cover. But the basic premise that most corporate treasurers work on is they are trying to eliminate risk," he said.
"(So) I think most would have covered the risk or covered it to acceptable risk tolerance." Another factor possibly limiting the impact of the current move on European corporates is the fact that although Friday's rally was sudden, most investors have for some time been expecting that the dollar would eventually weaken.
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