Plummeting pesos. Weakening yuan. Tariff announcements, whether real or threatened, have roiled the markets in recent years. In the domain of foreign exchange, the dollar generally has strengthened against the currency of the targeted countries.
Tariffs, some argue, will harm the American economy. The price of washing machines, ceiling fans, automobiles and even imported Mexican beer could rise as the cost of tariffs seeps into international trade. But as many worry, savvy importers have kept a cool head. They scoop up depreciated currency when the dollar spikes, employing opportunistic hedging strategies to mitigate the rising tariff tide.
A Very Brief History of Tariffs
Tariffs are not new. The word itself appears to derive from Arabic and Italian sources, with some references dating to the late 1500’s.[1] The United States employed its first tariff in 1789, mostly to generate revenue for the fledgling government.[2] By the early 1900’s, however, Americans inclined toward the benefits of free trade, and tariffs fell mostly out of favor. After World War Two, the United States led the creation of the General Agreement on Tariffs and Trade (GATT).[3]
Formalized by twenty-three countries in 1947, GATT took effect on January 1, 1948. Over the course of subsequent negotiations, an international rule-based trading system became the norm. GATT is widely credited for the expansion of international trade that occurred in the second half of the 20th century, ultimately resulting in the creation of the World Trade Organization (WTO) in 1995.[4] Today, the WTO consists of more than 160 members. According to the WTO website, membership represents 98% of world trade.
Is the World Still Flat?
International trade has skyrocketed since the early 1900’s. The majority of that growth occurred after World War Two, signaling the success of GATT and its successor, the WTO. By 2005, global trade advocates proclaimed the world as "flat," pointing to the leveling of the competitive playing field.
With the current administration, however, tariffs seem to have reclaimed a prominent role in global trade. Recent tariffs and the subsequent trade war have disrupted the journey toward a utopian trade ideal. In 2018 and 2019, the Trump Administration announced – and in some instances implemented - various plans to significantly increase tariffs against China, the European Union, Canada, and Mexico.
The Trump Administration has planned to use tariffs to reduce the U.S. trade deficit, improve America’s manufacturing landscape, and even protect America’s borders with Mexico. The Trump Administration also forecasts that the United States will receive billions of dollars from tariffs, which will be used to buy and distribute American agricultural products to disadvantaged countries as a form of humanitarian assistance.
While support for these policies is mixed, uncertainty is high. Aggressive trade policy has unleashed volatile market reactions. Various companies exporting from Mexico, for example, saw their share prices plummet on the rumor of tariffs.[5] To date, importers may have been the beneficiaries of these policies as the U.S. dollar typically experienced strength against the currency of the target country after each tariff announcement.
Importer Ideas
Following the tariff announcements in 2018, for example, the Chinese renminbi slid nearly 10% against the dollar from April to mid-August of that year. Weakness of the Chinese currency has continued throughout 2019 as the potential for further trade war escalations has hovered on the horizon.
Source: Bloomberg Finance L.P.
View accessible version of this chart.
Similarly with Mexico, simply the threat of tariffs has sent the peso lower. On one May trading day this year, for example, the currency slipped more than 2% against the greenback.
Source: Bloomberg Finance L.P.
View accessible version of this chart.
Agile importers can take advantage of sharp dollar moves. By employing FX hedging strategies – such as forwards and options – to mitigate their local currency exposures, the impact of rising tariff costs can potentially be reduced. In the case of the Mexican peso, for example, a 2% move in the currency market, plus the additional value of forward points, helped offset the majority of the threatened 5% tariff.
Source: Bloomberg Finance L.P.
View accessible version of this chart.
Importers trading only in U.S. dollars recognized a new reality – it is difficult to benefit from the depreciating currencies when invoices are denominated in U.S. dollars. Managing currency volatility can help companies to hedge at opportune moments of dollar strength, while benefiting from additional value found in the forward market. In the case of China, for example, shifting to renminbi-based trade can allow importers to capture the value of the depreciating currency and benefit from the value inherent to the forward market.
Source: Bloomberg Finance L.P.
View accessible version of this chart.
How to Prepare for an Unpredictable Future
As we near the end of 2019 and prepare to enter another election season, it is difficult to predict how tariffs may factor into the conversation. It is equally difficult to guess the extent of any market reactions.
Importers with a complete understanding of their FX exposures will be better prepared to take advantage of potential opportunities as they arise. For example, companies currently dealing in U.S. dollars might wish to negotiate new terms – denominated in foreign currency – in order to take control of, and potentially benefit from, the FX aspect of their international trade.
Ready to Help
Foreign exchange hedging tools can help you manage foreign exchange risk more effectively, secure pricing and costs, and potentially increase profits and reduce expenses. Connect with PNC’s Foreign Exchange experts to get a strategic perspective and tactical support for managing your business risk in an unpredictable global market. Contact a PNC Foreign Exchange Representative at 1-888-627-8703 or visit pnc.com/fx.
Accessible Version of Charts
CNH BBG Graph
| Year | Date | USD CNH Historical Rates |
| 2018 | Oct | 6.9752 |
| Aug | 6.8243 | |
| Jul | 6.8266 | |
| Apr | 6.2665 | |
| Apr | 6.2692 | |
| Mar | 6.2540 |
MXN Intraday BBG
| Date | USD MXN Currency Historical Rates |
| 6/3/2019 14:41 | 19.8777 |
| 5/31/2019 16:50 | 19.6165 |
| 5/31/2019 6:26 | 19.8124 |
| 5/31/2019 0:38 | 19.553 |
| 5/31/2019 0:01 | 19.5678 |
| 5/30/2019 13:28 | 19.0592 |
USD - MXN Foward Curve
| Date | Points (Mid) | Callout Points (Mid) |
| SP | 0.0019 | |
| 1W | 0.0220 | |
| 2W | 0.0441 | |
| 3W | 0.0660 | |
| 1M | 0.0944 | |
| 2M | 0.1992 | |
| 3M | 0.2906 | 0.2906 |
| 4M | 0.3917 | |
| 5M | 0.5028 | |
| 6M | 0.5971 | 0.5971 |
| 7M | 0.6999 | |
| 8M | 0.8060 | |
| 9M | 0.8989 | 0.8989 |
| 10M | 1.0029 | |
| 11M | 1.1069 | |
| 1Y | 1.2076 | 1.2076 |
| Current spot | 19.1700 | |
| Callout Dates | Callout Points (Mid) | % Change |
| 3M | 0.2906 | 1.52% |
| 6M | 0.5971 | 3.11% |
| 9M | 0.8989 | 4.69% |
| 12M | 1.2076 | 6.30% |
USD - CNH Forward Curve
| Date | Points (Mid) | Callout Points (Mid) |
| SP | 0.0007 | |
| 1W | 0.0005 | |
| 2W | 0.0012 | |
| 3W | 0.0022 | |
| 1M | 0.0034 | |
| 2M | 0.0070 | |
| 3M | 0.0103 | 0.0103 |
| 4M | 0.0149 | |
| 5M | 0.0197 | |
| 6M | 0.0241 | 0.0241 |
| 7M | 0.0295 | |
| 8M | 0.0351 | |
| 9M | 0.0400 | 0.0400 |
| 10M | 0.0459 | |
| 11M | 0.0518 | |
| 1Y | 0.0575 | 0.0575 |
| Current spot | 6.9340 | Text Boxes |
| Callout Dates | Callout Points (Mid) | % Change |
| 3M | 0.0103 | 0.15% |
| 6M | 0.0241 | 0.35% |
| 9M | 0.0400 | 0.58% |
| 12M | 0.0575 | 0.83% |
