RiskOperational RiskInterest Rates Matter, But Your Plans Matter More

Interest Rates Matter, But Your Plans Matter More

Their concern is understandable for me after spending 20 years in treasury management and consulting roles, during which time rates and – accordingly – financial decisions (FIs) changed frequently. But to them I offer a holiday message sure to take the edge off faster than a glass of eggnog:

  • There are more certainties about the future effects of interest rates on corporate treasury environments than uncertainties.
  • There are specific actions you can take now to almost ensure a successful outcome regardless of the course rates take.

A Brief History

Hard to believe, but it has been five years since the federal funds rate was slashed to near zero and there it remains. The Federal Reserve took this extraordinary action following the onset of the financial crisis in 2008, with the intention of stabilising the US economy and the world financial system. It has stayed with this policy, in part to help European and Japanese officials combat their own financial crises. Low rates, combined with a series of bond buying programmes broadly called ‘quantitative easing’ (QE), have become the norm.

Those who speculate on the workings of the Fed are generally in agreement that it will keep the federal funds interest rate at the current low level of between 0.00% and 0.25% until mid-2015. Indeed, PwC’s research and analytics team, in conjunction with Oxford Economics, recently opined that: “Easy money isn’t going away anytime soon, especially with [Janet] Yellen’s nomination [as Fed chairman]”. Yet, as the US economy’s strength grows, the time for reversal of policy will eventually come. The uncertainty is primarily around when rates will rise and how high they will go.

As even those closest to the interest rate drama don’t know for sure what the future will bring, it is hardly productive for the rest of us to speculate on the specifics. A relatively simple thought exercise, however, reveals to us that we know more about the future environment than not. Armed with this knowledge, we can productively consider the implications to our businesses and plan our actions.

Playing on a famous Keynes quote, and at the risk of sounding like an economist I can confidently declare that in the long-term, the following are true:

  • Interest rates will rise.
  • Global influence on interest rates will continue to increase.
  • Senior corporate management will expect immediate analysis of potential impact following each interest rate headline.
  • The amount of information to be considered by business leaders will continue to increase while the time to react will decrease.

The Implications and what You can do

So, like all good corporate leaders, we must look ahead and consider how these certainties will affect our business. While there is not room here to address all of them, the following are some examples:

Debt: A rise in interest rates means the cost of borrowing will follow. The extent it impacts your company depends on how reliant you are on credit. This scenario analysis is fundamental and you should understand this impact backwards and forward.

Investments: Good and bad news here. The bad news: remember the fundamental principle, if a bond’s interest rate increases, its price decreases. One of the most common ways of aiding chief financial officers (CFOs) and treasurers is in helping them establish models that assess the impact of such changes on their portfolios. If your company has a substantial fixed income portfolio, this kind of model is a must. The good news is that you will finally be able to earn a respectable return on your money. The CFO will be eager to know how you plan to capitalise on that. Could you answer him or her?

Pensions: Your future friends, the pension fund managers, will be happy because higher rates will make the plans look better funded and may even increase the bottom line. Large industrial companies and utilities with high legacy costs are likely to benefit the most. Apply what you know about your business, cash flows and forecasting to proactively provide insight into the likely effects on the company overall.

Working capital (receivables and payables): As treasurer, part of being a strategic leader is looking across the business at issues you can collaborate on and this is a priority area. If interest rates rise, the cost of extending credit to your customers rises. The treasury skill set can make easy work of this scenario analysis. Should you plan to revise your pricing model or receivables terms? Sales may increase or decline. If a customer knows the cost of borrowing is going up, he may rush to buy more while he has the chance. Alternatively, long-term purchasing may decline. The sales team will be interested in walking through these scenarios and their consequences. Similarly, the benefits of extending payables terms to your suppliers may increase and the benefit of taking advantage of early payment discounts may decrease. Optimising working capital management must consider the embedded cost of financing within your business value chain.

Financial Risk: Your staffers managing interest rate risk have hardly been challenged by the past five years of low volatility conditions. Maybe it’s time to shake things up. Here’s a useful exercise: write out a headline such as ‘Fed to raise rate by 25bps’ and challenge your analysts to give you an assessment of the impact by the end of the day. Better to practice now than when the chief executive (CEO) asks for real. What does this suggest about your current funding strategy? Be sure to consider how your currency hedging program would change.

Data Analysis: Globalisation of business, new financial instruments, the decisions of other central banks and a host of other issues all represent more information to be considered when assessing the impact of economic changes. Business leaders recognise this information growth trend, but few of them have the technology infrastructure in place to benefit from it. If your data quality is poor, your decisions will be too – unless you are lucky. Many treasurers’ pleas for financial system upgrades and better tools were heeded following the financial crisis, but many others remain to be addressed. A business plan that highlights the value of a well-connected treasury organisation is a good start.

Management Reporting: In contrast to the increase in available data, there is a steady reduction in the necessary reaction time to that data. The pace of change continues to increase. If all of your models, forecasts and reports are produced in Excel, consider the amount of time it would take to respond to environmental changes and management’s queries. Highly manual treasury environments are no longer sustainable. Fix it now or it will hinder you later.

Distress or Productivity: Your Choice

Speculation about the future of interest rates and their impact on your company can be either distressing (if you focus narrowly on the short-term actions of forces you do not control) or productive (by recognising the certainties the future holds regardless of specific rate actions and making plans to address them). No eggnog required then.

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