Treasury Risk Monitor: inflation vs. growth – which should you be more concerned about?

23 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.

The big picture

Amidst a flurry of central bank meetings, markets are squarely focused on the risk that higher prices and supply chain bottlenecks lead to lower growth. For treasurers (and indeed in our own view), the most pressing concern is inflation – and what can be done about it.

Risk monitor for the week ahead

  • Markets are starting to look for a UK interest rate hike in 2022 , but we think it’s too soon. We expect any hawkish drift at the Bank of England (BoE) to be evolutionary rather than revolutionary as the committee balances solid gains in employment and high inflation against other softer indicators like earlier-than-expected fiscal tightening (National Insurance rises from April 2022) and the uncertainties around the closure of the furlough scheme on September 30th.
  • Still, central banks look likely to tilt in a hawkish direction this week. In addition to the BoE, the Fed, the Bank of Japan, and a number of Scandinavian central banks all met this week. Norway raised interest rates by 0.25% – the first of the cycle for a developed market central bank. In the US the main focus is likely to be whether the Fed projects a rate hike in 2022 in its forecast.
  • Inflation risks rise in the UK and Europe and could become more protracted. Consumer price inflation (CPI) in the UK hit 3.2% and in Europe 3.0%, both the highest in nearly a decade. Disruption in manufacturing supply chains has been a significant challenge, and in some sectors (such as autos) is clearly continuing to depress output. Labour markets remain tight in some countries and sectors, such as hospitality and transport. Commodity prices have also been rising sharply – particularly gas & electricity. Although each of these difficulties is ‘transitory’ in principle, the main risk is that they become more protracted and accumulate, leading firms to raise prices in order to protect margins and workers to raise wage expectations.
  • Markets are focused on the risk of higher prices and production bottlenecks leading to lower growth. Strong data from across developed markets and labour markets in particular provide good reason to think that may not be inevitable, and we expect monetary and fiscal policy to remain biased towards supporting growth at the risk of higher inflation. That said, we’re more concerned about inflation than growth, and continue to think bond yields will drift higher as a result.
  • Growth concerns have troubled stocks, but credit has (largely) remained immune. China is still troubling equity markets. The restructuring of a major property developer is compounding concerns about the ongoing cost of a ‘zero covid’ policy with the delta variant. Longer-term factors are at play, too, including the tightening of regulation in a number of other sectors, a broad push to rebalance growth, and geopolitical confrontation with the west. But against that backdrop, credit markets have remained mostly unscathed (with some exceptions at the lower end of the credit spectrum).

Trending with treasurers   

Hedging against inflation is naturally edging up the agenda

Firms are rightly focused on the sensitivity of their margins to inflation, 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.

Primary bond markets start to warm to infrequent issuers

Investors continue to welcome bond issuers with open arms, particularly infrequent issuers -Woolworths, Segro, Smurfit, and Adecco to name a few. The euro hybrid market saw the first US corporate - The Southern Co., a US utility – come to market. Indeed, the emergence of Yankee hybrids could be significant because the US market is so large.

Chart of the week

One reason we’re not especially worried about growth is solid jobs data – particularly hiring intentions, which point to greater optimism among businesses and higher economic output. In Europe, as the below chart suggests, businesses across nearly every sector are hiring.

Good intentions: hiring intentions are soaring in Europe

Sources: European Commission, NatWest Markets

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