According to the famous Warren Buffet, inflation acts as a gigantic corporate tapeworm (said in the 80’). Is this statement still accurate? And he even added that tapeworm pre-emptively consumes its requisite daily diet of investments in Dollars, regardless of the health of hosting organism. If you read the recent annual reports of large MNC’s, we can read a litany of events explaining how they have blown the best-laid strategy off course and often into unchartered waters. Although the market impacts have dissipated, the legacy over the longer term remains in the form of increased energy and food scarcity, disrupted international supply chains and, in some countries, high level of inflation. C-suites, having dealt with sharp operational shocks, have now to adapt, once more, to rising input costs. It remains complex to adapt pricing to new realities and to change components to mitigate pressures. Even if specialists predict that positive productivity shock may arise from Artificial Intelligence, it remains tough to assess. The fragility of the post-pandemic economy, combined with the fractured nature of global politics makes business models more susceptible to further unexpected shocks. These conditions when mixed into an unstable pricing environment increase risks of a corporate misstep and deepen its potential impact. When capital is constrained, as today, it is difficult to maintain optionality, a high-value commodity in a changing world. Inflation represents a cost of capital crisis, but also a cost of investment crisis, challenging companies C-level to find new ways to survive.
Tough to say whether we will face or not a soft landing of lower inflation without recession. Economists talk about “immaculate disinflation”, nice, isn’t it? We may say that all the main errors have been in underestimating inflation’s strength and persistence rather than overestimating it. The facts do not suggest there need to be many more interest increases to eventually defeat inflation. But with underlying inflation still too high on both sides of Atlantic, there is almost no coherent case to be made that most of the monetary policy tightening was ill-conceived. No one can know how the economies would have fared had central banks done nothing. There is a little doubt that excess demand would be stronger, inflation higher and the problem of persistent price rises would be worse. The steps taken to contain inflation were therefore almost certainly necessary and there is little case yet shout mission accomplished. One aspect of fight against inflation that is amazing is the lack of pain. Unemployment is a t a record level, at least in US.
Central bankers are under no illusion about inflation. Its threats persists and its outlook is complicated by structural shift in the global economy. However, the officials always claim that the current period is marked by unusual uncertainty. It is maybe true today given major shift operated. Central banks must reduce inflation and keep it under control. Demand in the US seems to remain persistently high and unemployment at its lowest levels, which do not help keeping inflation low(er). These elements and other could require higher interest rates for longer until inflationary pressures are definitely behind us. On top of that, supply conditions re far from being stable (again). Instead, economic analysis must encompass extreme supply shifts ranging from COVID lockdowns to fractures in supply chains to energy supply conflicts following war in Ukraine. Even the labor market trends are very difficult to assess with new home-working practices. We also face demographics and climate shifts spreading. Eventually Chines economy seems to slow down fast and Indian economy to boom. The world may deglobalize a bit and face a smaller growth in coming year. That’s the current complex context we are facing. In this context, with high interest rates (for a while as we can predict), refinancing or funding can become critical (when crucial). This increased cost of funding and spreads could make life of treasurers complicate over next months and prevent from servicing the debt. Men should not subscribe to storm insurance when the tornado already started. Nevertheless, on the upside, companies are offloading their pension schemes to insurers at a record pace on both side of the Atlantic as higher interest rates have provided a further impetus to the sector. High rate means that MNC’s can improve sharply solvency levels for workplace pension schemes, making a so-called bulk annuity deal affordable for many more businesses, and testing capacity in the market. In such deals, companies pay a premium to transfer a chunk or all their pension obligations off their balance-sheet to an insurer (e.g., in the US half of 23’ = 22bln USD of pension liabilities shunted over insurance companies). Unfortunately, insurers will have to prioritize cases having best chance of securing a transaction. Economic changing conditions do fortunately not impact all companies the same ways.
François Masquelier, Chair of ATEL
This article was prepared by François Masquelier in his personal capacity. The opinions expressed are the author’s own and do not necessarily reflect the view of the European Association of Corporate Treasurers (EACT).