The BIS has released its Annual Economic Report (https://www.bis.org/publ/arpdf/ar2018e.htm) in which it notes that the burden of resolving the GFC has been borne by central banks. They have acted to reduce short term interest rates by money market operations, and to reduce long interest rates by on market purchases through Quantitative Easing. The latter is now being unwound but, to date, unwinding of central bank QE in the USA and the EUR block has had little effect on long term rates and expectations of future rates (see Graph 1.3 in the Report) remain low.
However, BIS identifies potential problems due to increased absolute levels of borrowing across the government, corporate, and personal sectors, the potential risks of a volatile USD rate as trade wars continue, the potential for inflation to re-emerge, and that low money market rates provide little room for central banks to manoeuvre if another financial crisis emerges.
Treasurers and their employers have enjoyed a near 10 year run of low interest rates. Long term interest rates in the UK and the EUR block remain below inflation, a factor which has directly increased UK pension deficits on corporate balance sheets but has generally led to increased debt and gearing ratios and capital distributions. The obvious risk now is that these rates suddenly rise, “snapback” in BIS parlance, and refinancing costs increase.
That the run of low interest rates has continued for ten years is remarkable to those who experienced the thirty years prior to 2008 when five-year Gilt yields rose to 15.5%[1], mortgage rates peaked only slightly lower, and money market rates reached 15%. It was from this scenario that the ACT was born as corporate treasurers gathered to grapple with this high rate and volatile financial environment.
Treasurers need to consider the rate risks. The trade war has already moved from rhetoric to increased tariffs which will upwardly pressure inflation. The USA has experienced pushback on low minimum wages. Can UK basic wage, coupled with zero hours contracts be maintained as CPI rises? Oil remains above $70 a barrel. The USD has switched from depreciating to appreciating with a potentially disastrous impact on emerging market borrowers who rely on USD funding.
Against these downside risks we have some upside. BIS notes in section 1 of the report the potential for employment statistics to be materially underestimating the flexibility remaining in the labour markets world-wide as jobs move to low cost labour pools and labour moves towards jobs. Oil price may have peaked as OPEC recognises the burden of high prices on emerging markets. The USD is beginning to show signs of weakening as the new trade policy has unexpected results (see https://www.bbc.co.uk/news/world-us-canada-44610010 for the Harley Davidson story).
As our “The Business of Treasury 2018” survey shows, Treasurers engage in forming corporate strategy and have a good success record when advising their corporate boards. Has the time come to temper debt heavy capital strategies with a re-financing health warning?
[1] Bank of England Statistics: https://www.bankofengland.co.uk/statistics/yield-curves
