Q&A: Amol Dhargalkar On Interest Rates, Risk and Capital Markets

In our next interview instalment, we connected with Amol Dhargalkar, the Chairman of Chatham Financial, to gain insight into how companies are navigating today’s financial challenges. His perspective sheds light on major concerns around interest rates, market volatility, and strategic adjustments in various industries.

Pleasure to meet you, Amol. Do you mind telling us a little bit about you and what you do?

I’m the Chairman of Chatham Financial, a capital markets-focused firm working across a variety of industries: from commercial real estate, private equity, financial institutions, to manufacturing, retail, tech, telecom, we work across the entire spectrum. We provide our clients with advisory and technology solutions to address their capital markets challenges.  Our solutions range from derivatives and hedging to advising on capital structure and financing.

I’ve been at the firm serving clients for over two decades, where my area of expertise has primarily focused on been derivatives and debt capital markets. I spend a lot of my time speaking with treasurers, CFOs of large public companies, but I also have insights into a lot of private companies, private equity sponsors, and real estate firms.

What are the primary concerns of clients in the current financial market environment?

I think the number one priority on our clients’ minds is interest rates.

The number two priority is interest rates.

The number three priority is interest rates…

That is where most of the energy is focused right now, though it certainly differs by companies, capital structure, and industry.

For example, in the commercial real estate world there is a hope that interest rates will come down and create a little bit of breathing room for commercial property owners to be able to refinance or sell. On the other hand, investment grade public companies are not enjoying this period of higher interest rates, but they’ve had a relatively easier time of navigating it because of the nature of their capital structure. Multinational public companies have also been searching for ideas and solutions for how to lower their interest expense.

So, the main theme has been in response to inflation as rates have gone higher. The Fed, maybe a little bit uniquely across the globe, has certainly held at this higher level longer, while we’ve seen reductions by central banks, such as Canada, England, and the ECB. Though, that doesn’t mean that medium- to long-term rates have come down that precipitously. And in all cases, interest rates are materially higher than what they were just a few years ago. So, again, it’s a differentiated response but very high priority for anyone in capital markets and any treasurer is interest rates.

I’ll add on to that, recent labor market data and inflation data have come out weaker than expected. The market responded exactly as you would think. Rates across the curve are down significantly, with the market now expecting as many as 4 rate cuts by the end of the year. Tomorrow, we might get different data that sends market up 10 basis points, but really, it is anyone’s guess as to what different central banks will do.

A lot is hinging on the Fed right now, which seems to be taking a much more cautious approach as inflation comes down than they were as inflation was rising when the first instinct was to focus on this supply chain, post-pandemic-related issues, not necessarily something systemic. I think that they don’t want to make that same mistake again of letting inflation get away from them, hence a lot of the volatility that we see in the market because it’s just unknown what will happen.

How are treasurers dealing with uncertainty? Mitigating risks?

Let me share some tactics that we’ve seen companies use. The first is, if there’s a window to do a refinancing, for example, rates are down, spreads are down, everyone’s gotten to ‘stage five of acceptance’ on that rates will be higher for a while, companies can issue debt early, doing refundings, etc. For the investment grade universe (and even the high yield universe), there have been meaningful time periods, especially in 2024, where it’s been a great time to go to market and execute issuances at better spreads or better all-in levels.

The second set of tactics is using derivative or hedging overlay strategies to reduce either interest expense or interest rate volatility. There, we’ve seen two tactics that public companies or investment-grade companies have used on the high yield side. One is what we call ‘pre-issuance hedging,’ where they might not be issuing today but they know that they’ll be issuing six months to one year from now, and they’ll put in place derivative transactions to essentially lock in the base rate of their borrowing.

The other one that we’ve seen is cross-currency swaps where multi nationals borrow cheaper in Europe. They might not be able to quickly execute a Euro bond issuance or a Yen Bond issuance or Swiss Bond issuance, but they can synthetically convert dollar borrowings into Euro borrowings with cross-currency swaps. That tends to be another technique we have seen companies employ.

What are the main global events and trends that finance professions need to look out for?

All eyes are on the Fed. Will they move sooner? Will they move later? The US Fed is meeting again in September, which I believe will be the last meeting before the US election.

There’s a lot for companies to pay attention to. There are еlections happening across the globe, with the greatest number of voters going to the polls in the history of the world, when you add up India, the European parliamentary, and elections in Mexico.  There are also geopolitical conflicts, such as the wars Gaza and Ukraine, which could produce surprises in either direction that introduce new volatility to markets.

Additionally, there have also been a fair amount of production cuts by OPEC and oil producers, primarily related to softening demand, and the fact that we haven’t really seen crude oil prices materially increase, so while they are a little higher, there have been no mentions of $100+ crude oil, so there’s a little bit of a range-bound environment there. Something to keep an eye on is whether we will start to see the production cuts outstrip the slowdown in global growth and what that would mean for the markets.

The last thing that I haven’t really touched on – and it’s related to all these – is FX. We’ve had a relatively strong dollar. It’s not quite the strongest it’s ever been but it’s been holding relatively steady against most of the major currencies, though this has shifted in recent weeks. How will Fed rate cuts impact that? Would we see something significant from the bank of Japan, which is another longer-term impact area that companies are considering.

Those are a few big themes to keep an eye out on. While there is not necessarily a specific date or specific event, pay attention to the things that are not on page one of the news.

Some of these situations are in a state of sort of stable instability where something could go a certain, unexpected way. How do you advise your clients to prepare for unexpected changes in the economic environment?

One thing we’ve seen over decades of doing this is that it’s the surprises that get you. So, we encourage our clients to always be, for lack of a better term, stress testing everything.

It might be fine now but what if everyone in the US is expecting interest rates to stay higher than expected? Conversely, what if we hit a really bad patch or recession and the Fed cuts much faster than anticipated? In line with what the markets were thinking six to nine months ago, what does that mean for your organization? Particularly if you’re locked into a higher fixed rate capital structure? So, we recommend regularly conducting scenario analysis and, “what if” planning.

A lot is being said about the economic decoupling between America and China impacting the supply chains, generating economies and potentially creating new areas of influence for the two super powers. What have you seen about that?

Something that we have seen amongst our clients in the US, is that there has been a trend of nearshoring or friend-shoring.  For example, we’ve seen many clients move more of their manufacturing and other operations to Mexico. You can chalk that up to decoupling, you can chalk that up to supply chain diversification or manufacturing diversification, or lower cost of transportation, particularly if you’re a domestic trying to provide goods into a US market. There’s a variety of reasons for it, but we are seeing more of this whereas a decade ago the standard response from many manufacturers was that China was the first place to go.

We can look at the semiconductor industry as an example where there’s a fair amount of infrastructure and investment happening in the US. For companies, that changes the nature of some of their capital markets activity. If you’re building big plants in the US, that changes how you finance them and how you capitalize them. If your currency mix is changing from having renminbi exposure to having peso exposure. What does that mean and given how volatile the peso has been; it’s not a managed float like renminbi is. So, what does that mean for the organization? What will this mean 50 years from now? What are the consequences? How do we, as treasurers, help our organizations navigate through the strategic changes that we’ve chosen to make as a firm? These are the types of challenges we see our clients dealing with.

How is AI currently impacting the day-to-day activities of treasurers and capital markets?

I’ll start with the answer that maybe you don’t expect, which is that within the treasurers’ day-to-day, AI is not having a material impact yet. I think that’s true for public companies and a lot of different industries.

One of the reasons is that these are the elements of an organization that tend to rely most on data, but the challenge is they don’t have access to the data to feed into AI models so they can train them to do the things that you and I can do as consumers when we go on chat GPT. So today, there has been relatively little impact.

Of course, AI has broad-reaching implications and is impacting industries differently. It requires energy consumption and energy usage, and more data centre builds. So there are a lot of other consequences. But on a day-to-day basis we haven’t seen that dramatic impact yet.

The other issue is that if a company is going to invest in AI – and it seems like almost every company is investing in AI – they tend to do that for the purpose of their front office: revenue-generating type of capabilities or supply chain or different, more core elements of the organization rather than treasury and capital markets, which tend to be viewed as a supporting rather than critical function in most organizations. That’s going to be different if you’re a financial institution or non-bank lender insurance company, but capital markets activity tends to be secondary from an AI investment relative to other areas.

Final words for our readers?

While we’re in a time of intense geopolitical and financial volatility, none of what we’re experiencing is unprecedented.  The same fundamentals apply that have in the past. Continually assessing interest rate, FX, and commodity risk and developing strategies to manage those risks across different scenarios can enable organizations to weather the uncertainty ahead. The key is to address risk proactively, rather than reacting to the markets.