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How Could Q3 Corporate Earnings Season Affect Forex?

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Last Friday saw the unofficial start of Q3 earnings season. Over the next month, most major corporations around the world will provide updates to investors on profits and give an outlook for the rest of the year. CEO’s will comment on the state of their business, and what of particular interest to forex traders, the general economic environment.

Forex, of course, depends on the underlying economic situation. But multinational corporations are also the main drivers of cash flows between different currencies as they pay for products, make investments and repatriate profits. Central banks and governments respond to economic conditions faced by businesses, which also impacts the value of their respective currencies.

“Headwinds” is the term of the season

Many US firms have pre-announced results, in an unusual move. Virtually all of them have warned of negative results for the quarter. This is one of the factors driving US stocks lower. Among the reasons cited are “currency headwinds”. That is, the US dollar has been strengthening over the last several months, and profits generated overseas are worth less in dollar terms.

The Fed’s policy of pushing rates higher to fight inflation has outstripped most other currencies, making it difficult for US exporters. Importers, on the other hand, are seeing increased profits thanks to relatively cheaper imported goods. The result is that the trade balance will likely be increasingly negative, contributing to outflows of US currency. As long as the economic uncertainty persists, this is unlikely to affect the dollar. But, downward pressure is building on the dollar, which could be released at any moment when the Fed’s policy starts to soften.

Sequential over comparable

Traditionally, companies compare current earnings to the same period in the prior year. This helps avoid seasonality effects. However, last year was the middle of the delta covid wave, which would likely distort the “comparable” earnings. “Sequential” earnings are the difference between the current quarter and the previous one, which could take priority. Given the unusual situation, companies can be reporting knock-out comparable earnings, but disappointing sequential ones. Particularly travel and leisure stocks, given the shutdown of air travel last year.

European firms in particular were facing an increasingly challenging environment because of energy prices, which peaked at record highs over the last three months. However, since then, energy prices have cratered. They are still well above pre-war and pre-pandemic levels, but substantially lower. Therefore, the reports for European firms could be extraordinarily negative, and not represent the current (or future) situation. This could lead to further “paradoxical” behavior in the market, as traders price in the effects of energy prices into earnings.

The focus is still on retail

With monetary policy focusing on inflation, consumer behavior is likely to have the biggest impact on forex. Big retail firms like Walmart in the US, Casino in Europe, Tesco in the UK can give some critical insight into consumer behavior. Amazon and Alibaba can do so globally. Companies being able to pass on higher costs to consumers implies inflation can continue. AIf companies are starting to see margin compression as consumers refuse higher prices, it could mean that inflation is near its peak due to demand destruction.

Speaking of demand destruction, recession concerns can be read into earnings reports. Particularly in regards to the item of inventories. If companies are seeing their stock build up, they will be less likely to buy replacements. That in turn means inventory building up in other companies, who will buy less raw materials. In general, it implies slowing economic activity, and could be the precursor to layoffs. Company comments on inventories could be market moving this season.

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