FX Hedging in a Risk-on
/Risk-off Environment


Gerald Katsenga

Head of Corporate Sales,
Absa Regional Operations


As non-economic events send markets spinning into risk-on/risk-off uncertainty, corporate treasurers must be agile when responding to foreign exchange volatility

Economic textbooks might tell you that financial markets are driven by financial factors. But as Gerald Katsenga, Head of Corporate Sales: Absa Regional Operations, explains, recent events have changed that formula – adding new layers of complexity to traditional risk-on and risk-off formulations.

“Typically, a risk-on environment will see investors moving into areas that they would not typically go, as global economic patterns exhibit optimistic sentiment,” he says. “In a risk-off environment, market participants tend to shy away from riskier assets, so they’ll move their investments into safe-haven assets like gold or US government securities.”

Sharp spikes in risk uncertainty

But in the post-pandemic economy, textbooks have gone out the window. “In our current environment, geopolitical uncertainty has come to the fore,” says Katsenga. “Macroeconomic factors have ceased to be major drivers of financial markets globally, and indeed in sub-Saharan Africa in recent times. Instead, a series of non-economic events – most notably the Covid-19 pandemic and the Russia-Ukraine war – has seen global risk uncertainty rise sharply, with some of the key elements of the world economic order being called into question.”

Global economies have battled extremely high levels of inflation over the past year, with central banks globally accelerating their pace of aggressive rate hikes – some far more than others. As a result, financial markets have oscillated between risk-on and risk-off.

“The impact of recent frequent risk-on/risk-off oscillations could not have been felt more in sub-Saharan Africa,” Katsenga says. “They have driven huge foreign exchange (forex, or FX) volatility swings for SSA currencies. For example, while the United States saw hikes as high as 75 basis points (bps) to tame inflation that peaked at 9.1% year-on-year, Ghana experienced rate hikes of 250bps as inflation surged to more than 54%.”

Added to that, hard currency liquidity dried up in many SSA markets, including Nigeria, Tanzania, Kenya and more. “Local FX hedging has become difficult, and in some cases has led to trapped cash, as corporate treasurers aren’t able to move cash out of the SSA country into their central hub or back to the parent company,” he says.

Managing liquidity constraints

The current challenging environment will, naturally, pass. “As surely as risk-on risk-off cycles come and go, so too do liquidity challenge cycles,” says Katsenga. “As markets normalise, we will invariably start to see a wider selection of local FX hedging instruments, and hedging costs will come down as local markets provide sufficient liquidity at low volatility.”

In the meantime, to alleviate some of the challenges of limited local FX hedging owing to liquidity constraints, he suggests that corporate treasurers in SSA might consider FX hedging offshore with non-deliverable forwards. “This is something that we at Absa support via our central FX hub in South Africa,” he says.

He adds that corporate treasurers who are seeking alternatives for trapped cash should be agile and think beyond the short term. “One might consider alternative local investments that protect economic value,” he says, “like investing in local eurobond government securities. At the same time, one might consider longer-dated FX hedges that can be unwound when the next opportune risk-on cycle injects liquidity. You can never eliminate the effects of volatility, but you can limit its impact on your balance sheet.”

That’s some comfort for corporate treasurers whose careful planning has been derailed by unpredictable geopolitical events like the pandemic and the war in Ukraine. And, as Katsenga concludes, proven solutions exist for the challenges associated with swings in risk appetite. “Absa supports corporate treasurers with relevant, local-market FX colour in all our SSA jurisdictions,” he says. “We continue to offer both local and offshore FX hedging solutions all through the cycle – whether it’s risk-off or risk-on.”

Gerald Katsenga

Head of Corporate Sales, Absa Regional Operations

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