Fears that the Fed will moderate the pace of its quantitative easing (QE) policy by year-end have awoken fixed-income investors from their complacent slumber and triggered a disorderly global rout.
However, on the surface, the prospect of rising US yields indicates a healthier economic environment for corporates to deploy their vast cash surpluses for productive purposes, either by sinking that cash in higher-returning products or re-investing excess liquidity to grow the business.
“A rise in interest rates, having been so low for such a prolonged period of time, is an indication of a healthier economy and corporates are getting excited about the prospect of a recovery,” says an optimistic Suzanne Janse van Rensburg, EMEA head of liquidity, investments and managed treasury liquidity services at Bank of America Merrill Lynch.
“If the Federal Reserve [engineers a tightening of US monetary conditions] as recent statements indicate, then we may see more variations in interest rates and an increase in investment opportunities for corporates flush with cash,” says Lisa Rossi, global head of structured liquidity products in global transaction banking at Deutsche Bank.
However, the panic that greeted the Fed announcement, with equity markets around the world tumbling, suggests the disconnect – between improving US economic fundamentals and market pricing – could complicate corporates’ liquidity strategies.
While Ben Bernanke’s comments were measured and contained few surprises, the ensuing sell-off demonstrates the extent to which the world has become addicted to QE.
The sheer extent of central bank stimulation in recent years has distorted the market, divorcing monetary policy from underlying market realities. Crucially, the world economy is in unchartered territory and there is no knowing how markets will react when the crutch of QE is eventually removed.
The reaction to the mere mention of the prospect of a moderation in the pace of QE over a prolonged period does not bode well for market stability.
“I don’t think people are surprised by the fact that rates will rise, but they may have been surprised by the abruptness and that’s what’s caused markets to wobble,” says Jose Linares, head of global corporate bank at JPMorgan in EMEA.
However, he does not believe that implies the eventual raising of rates will be accompanied by similar levels of market panic.
“If rates rise because of an improving economic environment, not only will companies get paid more for their cash but they will also become more confident in putting that cash to work, and the logical use is M&A,” says Linares.
US non-financials alone held $1.78 trillion in cash and other liquid assets at the end of Q1, according to the Fed, while UK corporate cash balances hit £671 billion in Q3 2012, equivalent to 46% of GDP, up from £240 billion in 2002.
All this suggests transatlantic corporate cash balances might have reached their zenith as US and UK economies improve.
However, many disagree with this call, citing pre-crisis structural shifts in corporates’ liquidity management practices, such as tax arrangements, new regulation, growth of cross-border counterparty risks and the rise of research-and-development spending.
In the US, many blame the tax code for encouraging corporate cash hoarding offshore, with any attempt to repatriate cash to invest at home likely to be met with a hefty tax bill.
Meanwhile, regulatory transition is adding to the mood of uncertainty that encourages corporates to build up rainy day funds. Basel III, for example, while easing corporate fears over banks’ counterparty risks, threatens to increase the cost of accessing banking facilities.
Nevertheless, “the biggest issue facing corporates right now is a lack of attractive places to put their money”, says Rossi. “Corporates have been sitting in the stands for a long time now, but that has less to do with fear than a lack of opportunities.”
It’s unclear the extent to which a change in the rates environment could alter this calculation. In recent years, depressed interests rates mean cash in hand is relatively expensive to hold, which means that as rates begin to rise the cost of holding cash will decrease. At the same time, the weak growth environment has disincentivized capital investment.
Treasurers and CFOs must therefore decide whether to invest for growth or maintain their siege mentality in the expectation that things will get worse before they get better.
Corporates might be well advised to pre-empt central banks successfully raising rates by locking in the current lows rates to finance capital expenditure now.
“We see two seemingly contradictory trends playing out,” says Roger Bayly, senior advisory partner at KPMG. “People are starting to put their money to use, so we might see that cash pile start to fall a little bit. But at the same time, for some boards levels of uncertainty are also rising.”
However, this process is still in its infancy. “Corporates only feel confident to increase investment in inventory when they expect growth in the economy that supports the investment,” says Rossi. “We are not seeing that growth globally yet – or see enough of it to change their investment strategy.”
There might be some level of uncertainty fatigue – there is only so long corporates can adopt a wait-and-see approach. But corporates are also being careful about what they spend their money on.
Cost reductions, reviews of hedging strategies and other measures to increase their resilience are the priority, though there is also investment for growth and an increasing focus on potential M&A, says Bayly.