Treasury Risk Monitor: how can you hedge against inflation & cost pressures?

30 September 2021

Giles GaleHead of European Rates Strategy

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

Coronavirus trends are broadly improving with the return to school in full swing, but higher inflation and concerns over global growth are driving expectations of higher borrowing costs down the road, while cost pressures and supply chain constraints also make the list of top risks this week.

Risk monitor for the week ahead

  • Pandemic trends are improving globally, but in the UK, Europe, and the US, colder weather is upon us and remains a key risk. The UK is among the countries with the highest infection rates, but with more serious forms contained by vaccinations, restrictions continue to be lifted. In the US, caseloads have fallen around 40% from the recent peak and Asia has largely contained delta, so far. Infections remain very low in Europe. But colder is to come, which for some regions remains a key risk to monitor. Check out our Covid-19 Monitor for regular updates on how the pandemic is trending and key risks on the horizon.
  • Inflation is rising, which has central banks spooked and could lead to higher rates (and bond yields) sooner than expected. In Europe and the UK, spiking energy prices and labour shortages in key sectors (hauliers primarily) is causing major headaches for businesses and putting pressure on prices at a time when inflation is already quite high. In the US, inflation was a reported to be a little weaker in August, but manufacturing surveys pointed to higher price pressures being passed on. Whether transitory or not, higher inflation for longer means normalisation will also take longer, which means upward pressure on bond yields.
  • As we’ve pointed out in the latest episode of Bondcast, higher inflation has central banks worried, and may push them to contain inflation more actively. Last week, Norway’s central bank was the first of any G10 central bank to raise interest rates. The Fed, in signalling an expectation that it would try to end its net asset purchases by the middle of 2022, also sent a more aggressive message to markets. The Bank of England also sounded more concerned, allowing markets to project a start to rate hikes early next year (by 0.15% in February) more confidently.
  • These two factors, broadly higher inflation prints and the prospect of swifter central bank action, means inflation-linked markets have become very volatile. In the UK, where energy prices, labour shortages and supply chain disruptions are particularly acute, this has also meant a weaker pound.
  • Growth risks in China are to be watched. Last week started with serious concerns about debt sustainability and corporate bond defaults, which have reignited fears over asset bubbles and the effects of its longer-term economic rebalancing efforts. Our Chief China Economist Peiqian Liu has trimmed her growth forecast for this year and suspects there will be more to cut in Q4.

Hedging against inflation is naturally edging up the agenda

Firms are rightly focused on the sensitivity of their margins to inflation and supply chain pressures, both from a revenue and cost perspective. Some are reassessing their willingness to hedge inflation-linked revenues and lock in what are multi-year highs, while others are concerned they may have hedged too soon given mark-to-market moves of previously-hedged inflation cashflows in recent weeks. For many, pre-hedging of future borrowing is becoming a higher priority.

Optimising cash management with higher rates in mind

Lower-for-longer was the prevalent rate environment well before and throughout the pandemic, but the prospect of higher rates has treasurers reviving cash management discussions as yield improves on a wider range of products & markets.

Supply chain disruptions are making headlines everywhere, perhaps no more than in the UK where a shortage of hauliers is keeping some fuel pumps dry and weighing on a much broader range of industries. But similar pressures are being felt globally – including the US, where businesses now see supply chain issues sticking around for some time. This could have significant implications on growth expectations, but also highlights the importance of investing in building supply chain resilience.

When US companies think their supply chains will return to normal

Sources: Federal Reserve Bank of Dallas, Texas Retail Outlook Survey, NatWest Markets

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