Corporate treasury teams should look forward to a rosier economic outlook and better returns from liquidity funds, say Aviva Investors’ Stewart Robertson, Senior Economist for UK and Europe and Richard Hallett, Head of Liquidity Portfolio Management, speaking in a recent webinar.
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The economic outlook holds real reasons to be optimistic. Economies are recovering from the pandemic and inflation and rising interest rates are a sign of economic growth and the return to more normal economic conditions.
Inflation is likely to spike further, but it is also likely to be transient, particularly since one of the main contributors to current inflation levels is high energy prices. They account for between 1.5% – 2% of the inflation rise but are forecast to fall back, says Stewart Robertson, Senior Economist for UK and Europe at Aviva Investors. Although inflation brings challenges, it is also indicative of our journey back to more normal economic conditions.
Supply chain issues are leading to higher inflation and are front of mind for many corporate treasury teams. But pressures in the supply chain should ease as supply begins to catch up with demand. Freight rates already look like they have peaked, and the global chip shortage is starting to ease. “It is a good news story and governments are right to think about withdrawing the policy stimulus,” says Robertson.
A rise in interest rates makes sense given the stronger economic outlook. “If we are optimistic, why do we need emergency policy settings anymore?” he says. Moreover, markets are anticipating policy change, indicative in the yield curve moving to reflect interest rate rises ahead and the sterling curve now pricing in 1% for base rates next year.
The recent sell off in the bond market is also reflective of a growing awareness that rates are going to rise. One of the reasons equity markets have not sold off is – in keeping with a more optimistic view – economic growth ahead. Expect corporate bonds with weaker balance sheets to suffer most and “old world” corporate bonds in sectors like tobacco or oil to underperform, says Richard Hallett, Head of Liquidity Portfolio Management at Aviva.
Rather than viewing the prospect of monetary tightening with concern, corporate treasury teams should see higher interest rates as a reflection of things getting better. Although policy rates will climb over the next few years, they will do so in an orderly fashion and are unlikely to be as high as they have been in the past. “We need to get used to a slow journey to tighter monetary policy,” says Stewart.
Liquidity
The positive macro backdrop suggests treasury teams might finally be able to tap better returns on their cash holdings. Corporates are beginning to take advantage of more return seeking strategies and taking on a little more risk; tying up cash for longer and taking some credit risk gets better returns than six months ago, notices Hallett. He also notes a spike in demand for segregated mandates as companies with large amounts of cash on hand seek better returns than a traditional liquidity fund via a bespoke mandate.
Treasury teams can tap different strategies to position their cash portfolios for the rise in base rates. For example, corporates can reduce duration strategies and buy shorter dated products or floating rate products, balanced perhaps by fixed rates in the longer term. “Treasury teams are finally getting paid something for their investment,” says Hallett.
Going forward he advises treasury to focus on new restrictions in MMFs bringing both benefits and challenges. ESG integration in short term liquidity funds will also become more of a priority. “We are going to see more liquidity funds have to demonstrate they have green policies and are embracing the ESG ethos,” he concludes.
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