Exchange Rate Volatility Hampers Earnings: Who Gets Blamed?

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Following last month’s Federal Open Market Committee (FOMC) meeting, the euro-U.S. dollar exchange rate (EURUSD) fell to just over 80. Less than a month later the EURUSD came within a few ticks of 85, and today it is back down just below 83. That level of volatility plays havoc with corporate profits and the Federal Reserve is getting the blame.

The Coca-Cola Co. (NYSE: KO), for example, posted profits that would have been 3% higher except for the strength of the dollar. Johnson & Johnson (NYSE: JNJ), Abbott Laboratories (NYSE: ABT) and Philip Morris International Inc. (NYSE: PM) also cited currency exchange rates as nicking earnings by as much as 2.5%.

The dive in the dollar after the FOMC meeting announcement came less than a month after the dollar index (DXY) had hit a three-year high. As Fed officials walked that talk back, the dollar recovered to a new three-year high, but about half that gain is gone again, as it now seems pretty clear that the Fed’s asset purchases could begin to slow by the end of this year while interest rates are likely to remain near zero. Provided that the Fed’s September meeting does not toss another curveball at corporations and investors.

The world’s other major reserve currencies, the yen and the euro, are expected to continue to weaken against the dollar for the rest of this year and into the first half of 2014. But that general weakening will include a lot of ups and downs, and volatility will still rule in the world’s $4 trillion daily forex markets.

Corporations will do what they can to hedge their exposure to currency swings with forward contracts and other instruments, and hedges will cost more because the currency markets will price in the volatility, adding to the exchange-rate headwinds that U.S. companies face.

The game really comes down to a matter of timing when the music will stop. And the music will not stop until the Fed does something instead of just talking about perhaps doing something in the near future if conditions warrant and … [fill in the blank].

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