In just two rate hikes the Fed has pushed its benchmark rate all the way to 1.75%. Are we entering into a new interest rate environment? We look here at what led us to such a fast interest rate normalization and the opportunities it unlocks for cash management.
It is undeniable that since the pandemic hit the economic world has been struck by a combination of completely unforeseen and atypical shocks. From the supply chain constraints to the tightness in commodities markets we are still, today, witnessing the consequences of the original impact of COVID as well as the policy responses to it.
Act 1: Demand shock
Originally COVID hit the economic world as a giant demand shock with consumption taking a plunge at the onset of the pandemic. This was the result of the large increase in unemployment which led to a downside shock in aggregate demand and consumption. This type of shock naturally creates deflationary pressure (as we studied in Econ 101: less demands for goods means lower prices which means deflation).
Act 2: Supply shock
But very quickly this demand shock was followed by a supply shock. As the pandemic meant quarantines and lockdowns this prevented a large part of the supply chain from functioning as a lot of employees were forced to stay at home. This resulted in a decrease in supply of goods, which typically results in inflationary pressure (less goods supplied means they are more scarce and so more valuable which means higher prices).
Act 3: Government stimulus
On top of these two shocks we experienced a large amount of government stimulus; as depicted by the large budget deficit experienced in 2020. At that time, the government increased its spending and provided stimulus checks to counter the difficult economic situation as the economy plunged into recession. The effect of such policies is to reflate and stimulate the economy with a net impact of generating inflation.
An ex-post analysis of these three shocks clearly identifies the root cause of the inflationary situation we are in. As the economy weakened, the government stimulated the economy at a time when there was less supply of goods available. In retrospect the COVID recession we saw in 2020 was very different from the traditional demand shortfall. It was a demand and a supply shortfall. Arguably the large fiscal and monetary policy responses planted the seeds of the inflationary pressure we are seeing now (on top now of the Russia-Ukraine war which is adding some fuel further exacerbating the high oil prices).
The impact on interest rates
As we are dealing with the inflationary consequences of the crisis and policy response to it, not everything is negative. One positive is the fact we are dealing with maximum employment. On the other hand this also creates a further tailwind for price pressure which puts the Fed in a position where it has to mop up the excess liquidity and aggressively hike rates. In light of this, with inflation hitting a 30 year high the natural policy response might then well be to provide the largest rate increases seen since the 90s.
The consequence for cash management
As a result of the 2008 crisis the following decade was characterized by ultra low rates as it took a long time for the economy to recover from one of the greatest recessions seen since 1929. We might now be in a very different rate environment which in turn opens a lot of opportunities in terms of cash management. While the previous decade provided very little incentive for businesses to think about what to do with their cash balance, the current new environment rewards proactive cash management given the higher interest rate and the higher revenue which can be generated on idle cash.
As the chart shows and to put things in perspective, the markets now expect the Fed rate to be 3.5% by early 2023. This isn't the type of regime where it makes sense to accept a rate of nearly 0% on a cash balance sitting idle at a bank. Inaction is no longer an option.
As we look ahead
For CFOs and finance executives, when it comes to cash management being passive is no longer an option. Not only is an active stance now being rewarded via the higher interest and the ability to monetize a company's idle cash, but there are also solutions available (hint: Treasure) to seamlessly optimize the revenue that can be generated from a business’ cash balance. Time to make your cash perform!
Ben Verschuere - Chief Investment Officer
Treasure Investment Management, LLC
Disclaimer: The views and opinions in this piece are just the author's own, offered to the public at large and not to any one particular investor.