Corporate Treasury Weekly: summertime… and the monetary policy is easy

20 May 2021

Giles GaleHead of European Rates Strategy

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Breaking down trending trades & themes to help corporate treasurers get ahead of the latest issues shaping markets.

Global inflation is the big story heading into the summer, and while central banks may be willing to tolerate a sharp inflation spike and keep monetary policy easy, markets may not be so obliging. We see rising bond yields ahead – in slightly different ways across the UK, Europe, and the US – but credit should remain steady. Meanwhile, an accelerating UK economic recovery is feeding a stronger Pound and has corporates, especially importers, focused on currency hedging.

  • Global inflation is the big story of the summer – will it be transitory or more longstanding? With US data clearly pointing to strong demand and bottlenecks in the supply of labour and supply chains (April core price inflation reached 4.2%, the biggest monthly increase since 1981), April UK data showing large retail price inflation overshoots and a European economic recovery taking greater shape, markets are focused on whether a global inflation spike is short-lived or something more longstanding. We think markets may need until September to decide, which is why we think that’s when we can expect big new decisions on key central bank policies like quantitative easing (QE).
  • Expect shorter-term yields to rise faster in the UK, long-term yields in Europe: In the UK, we expect shorter-term bond yields to rise more quickly as markets start to project rate hikes on the back of a strong economic recovery. But in Europe, we think subdued inflation is more deep-rooted and that unwinding QE is a much greater risk because it is the glue that holds many regional markets together. Long-term yields may be seen to be too low as inflation expectations and, eventually, reduced QE are factored in, which is why we think they are likely to rise quickest.
  • Credit is steady but government spreads may be a risk: Strong investment flows continue to support the credit outlook, and the global recovery should keep concerns about the asset class at bay. But a recent widening of sovereign bond spreads could pose a risk, particularly at the lower end of the credit quality spectrum.
  • Sterling, commodity-linked and emerging market currencies should strengthen: Sterling’s outperformance – particularly against European safe havens like the Euro and the Swiss Franc – could extend a little further with virus trends looking favourable and the economy’s recovery expected to be rapid and robust. Meanwhile, a dovish Fed amidst rising global growth is negative for the US dollar. Finally, we don’t think investors are factoring the global recovery strongly into emerging market currencies – but they should, as we expect them to do well.

Corporates – especially importers – prioritise hedging amidst a strengthening Pound

For importers, who are typically buyers of the Euro and US dollar against the Pound, we saw a marked uptick in hedging activity once the GBP to USD crossed the 1.40 level, both for short-dated tactical needs and longer-dated FX forwards and structured hedging.

Corporate caution in some segments may prevail

Despite the broad rise of economic optimism in the UK, the tail of uncertainty that remains for certain industries or companies (as new virus variants rear their heads) is prompting some to reduce their hedging ratios overall. Not over-committing to currency purchases is a strategy that has been rewarding amidst a strengthening Pound, so we anticipate many importers to remain cautious.

The latest UK labour market data provide a clearer sense that recovery is underway: 5 consecutive months of rising Pay As You Earn (PAYE) employee numbers, with accelerating growth and evidence of a normalisation in new job creation (see below).

UK PAYE employees: monthly change from 2015-present

Sources: UK Office for National Statistics, NatWest Markets

And as the chart below shows, job vacancies rose throughout Q1, suggesting firms were largely unfazed by the Q1 2021 lockdown.

UK job vacancies & employment (%, 3-month average year-on-year)

Sources: UK Office for National Statistics, NatWest Markets

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