EuroFinance

 Jerome Powell, Chair of the Federal Reserve of the United States, emphasised during the recent Federal Reserve meeting in June that inflation has eased substantially from a peak of 7 percent to 2.7 percent but remains too high. “We are strongly committed to returning inflation to our 2 percent goal in support of a strong economy that benefits everyone,” Powell stated.

The challenge of managing liquidity in this high-rate environment has led to innovative strategies and creative solutions. At the 2024 EuroFinance Global Treasury Americas Miami conference, treasurers shared their perspectives and strategies on overcoming liquidity challenges in these demanding times.

David Andolfatto, professor and chair of the Department of Economics at MHBS, University of Miami, provided crucial insights into understanding the Federal Reserve’s decisions. “If we want to understand where interest rates are likely to go, we need to identify the inflationary or deflationary forces that are likely to emerge,” he explained. According to Andolfatto, while U.S. monetary policy is relatively transparent, the Federal Reserve’s response to inflationary pressures remains a key determinant of interest rates. The Fed can be expected to raise interest rates against signs of inflationary pressure and cut rates against signs of economic weakness.

“As for where we stand now, the Fed has no history of cutting interest rates when inflation is above target and there’s no imminent sign of recession,” he noted. Given this policy perspective, Andolfatto suggests that long-term rates are unlikely to decline soon and may even increase. “I think my outlook stems from the prospect of growing geopolitical tensions,” he added.

“I think China has emerged as a legitimate rival to the United States and it will exert its influence, especially in Southeast Asia and possibly beyond. And I think the United States will try to defend its interests around the world and that this effort will place a large fiscal burden on the U.S. government.” The growth of government spending and debt is inflationary. The Federal Reserve would monitor the potential impacts on interest rates and inflation, he noted.

Managing liquidity challenges

In response to these economic conditions, corporate treasurers are employing a range of strategies to manage liquidity. At American clothing manufacturer Perry Ellis International, VP and treasurer Mike Giakoumatos champions proactive financial strategies to counter the challenges posed by rising interest rates. “Despite the challenges posed by COVID-19 and rising interest rates, our proactive strategy of setting aside reserve funds has proven beneficial,” he said.

Giakoumatos added, “In our forecasting models during periods of low interest rates, we have scenarios that rates will increase, which is why the Perry Ellis financial team was prepared and built a plan of action that helped us navigate this situation.”

Additionally, the treasury team at Perry Ellis hedges its interest rate exposure by fixing rates on portions of its Asset-Based Lending (ABL) facility. “We hedged our ABL facility by using a flexible rolling structure, allowing us to take tranches and lock them in for 3, 6, or 9 months,” Giakoumatos added.

“We opted for six-month and nine-month contracts, fixing the interest rate. This strategy proved advantageous as interest rates increased, securing a fixed rate for approximately 75% of our facility, effectively making it feel like a fixed-rate loan,” Giakoumatos noted. This hedging strategy lessened the impact on the company’s increased interest expenses, shielding it from excess market volatility. This careful planning ensures the organization remains financially resilient and adaptable amidst potential economic fluctuations.

Giakoumatos added that the Federal Reserve is not expected to lower interest rates soon, necessitating a rethinking of the strategy at Perry Ellis as contract renewals have approached. “Considering the current economic outlook, it may be necessary for some contracts to be extended,” he said. Although rate cuts were expected around June or July, it now seems more likely to occur in September or December, according to Giakoumatos.

He also emphasised the importance of the cash management process to address liquidity management. He noted the critical importance of maintaining a watchful eye on evolving situations. The focus at Perry Ellis International is on the yearly plan and forecast, which drives liquidity management. The forecast is updated weekly and monthly, guiding decisions regarding available funds, payments, and overall financial strategy. Constant forecast updates and vigilance regarding other areas of the company, collections, strenuous expense management, as well as working capital management, are essential. All these elements must be synchronized to achieve optimal liquidity and navigate through financial challenges effectively.

James Krikorian, VP and treasurer at Krispy Kreme, a multinational doughnut company, has adopted a diversified approach. The liquidity strategy did not begin when the Federal Reserve started hiking interest rates. According to Krikorian, it commenced early in his tenure, identifying which of the multiple banks in the credit agreement would be instrumental to success. Efforts were concentrated on collaborating with these banks within the credit agreement, which primarily consisted of a term loan and a committed revolver.

Over the years, the organisation’s commitments with these core banks allowed for successful refinancing twice—in 2019 and again in March 2023, amidst the banking crisis—achieved without a credit rating, relying on strong relationships, Krikorian added. “We’re a dozen business, and I have more than a dozen banks,” he shares. When Silicon Valley Bank was faltering, Krikorian’s board advised against cutting banks or stressing them. Instead, they focused on accepting what each bank could offer.

“The strategy of being diversified and not overly centric to the US was emphasized. As they conform to Basel II, some European banks have already adapted, and their cost of funds is improving as a result,” he said. “Sharing business among a dozen or more banks requires tough discussions to make them understand they cannot have 100% of the FX business, 100% of the interest rate swaps, or all of the global cash management.”

Krikorian emphasised the need that no single institution dominates their financial services, particularly in areas like foreign exchange, interest rate swaps, and cash management. Just as a diverse portfolio of equities helps cushion against unforeseen shocks, a diverse pool of lenders can provide similar resilience, he added.

Navigating the challenges of high-interest rates requires a blend of strategic foresight and diversified risk management. By understanding broader economic trends and implementing proactive financial measures, companies can effectively mitigate the impacts of prolonged high-interest rate periods.