As inflation reaches its highest level for 40 years and interest rates pick up, treasury needs to respond to the risks and opportunities.

Inflation continues to rise at record rates, with a painful spike in consumer prices not seen in 40 years. Consumers, governments, corporations and investors have all been adjusting to new considerations. Nonetheless, the essentials of inflation don’t falter; as always, it hinges on supply and demand. Supply has been severely disrupted as a result of COVID-19, and is now made more complicated by geopolitical conflict, while demand increased significantly due to COVID-19 and supply chain issues. This led to a significant fiscal policy response, especially in the US, which delivered a strong economy that is currently operating above trend.

The Fed’s response

It is challenging for central bank policy to directly affect the supply side of the economy, but it can help cool demand. Tightening financial conditions helps to bring supply-demand equilibrium back into better balance.

Central banks have two tools at their disposal to achieve this. On one hand the Fed can increase the level of overnight interest rates, thereby increasing interest rates broadly. In another approach it can reduce the size of its balance sheet, or quantitative tightening (QT). This will be done slowly and methodically.

Treasury’s considerations

For companies with significant debt, financing costs will increase. But for companies carrying record levels of cash on their balance sheet (thanks to government stimulus and monetary policy in the last two years), increased global interest rates could mean an investment opportunity. This is an option for the cash hoarders that haven’t seen much return or yields on those balances in the last two years.

These conditions are not an isolated event to a particular country. For multinationals often dealing with as many as 30 different currencies, it can be challenging to keep up. Treasury should stay close and connected to banking partners and be prepared for all sorts of different inflationary and market scenarios and be ready to revise forecasts. A forecast done in December is probably already outdated, given all the shifts in the various yield curves and central bank expectations.

Treasury should also leverage technology. The more accurate cash flow forecasting is, the better liquidity levels and ensuing ability to react to central bank moves.

Segmentation and liquidity

Good, prudent treasury management is the best strategy to mitigate the impact of inflation. Most depends on how the balance sheet is constructed and what the composition is.

Treasury should segment the cash portfolio and find the right option for each segment or each bucket: day-to-day operations, medium-term needs, and longer-term strategic requirements.

Maintaining liquidity is also key. Treasury should anticipate rising rates, geopolitical concerns, and broader market volatility that is making clients cautious. Lastly, finance teams should extract the most value of cash by using solutions (for example, the earnings credit rate product in the US) which allows a fully automated way of offsetting bank and treasury fees.

Keep an eye out for next month’s Thought for the Month.