It is now a well-known story that for the last two years, the world has been financially flooded by easy and very cheap money from the FED (US) and the ECB (Europe). The FED balance sheet has now reached almost one third of the US Federal debt and both the ECB’s and FED’s balance sheet have grown to the staggering figure of EUR 8.75 Trillion and USD 8.94 Trillion, respectively. This has been done in the last two years by Central Banks actively purchasing issuances of state and corporate bonds. Next to this, central banks on both continents have kept short term interest rates at or below zero. The effect has been to keep long term borrowing rates very low in the US and even negative in the Euro zone for high-rated countries such as Germany.
Both the European and US economies are now running at full employment, with the US unemployment rate below 4% and the European close to 6%. As expected, inflation (which had been very low in recent decade) has picked up in both regions to 8%, creating a huge debate on whether it is transitory or permanent. As an answer to tight situation in the labor market and inflationary pressure, salaries have increased.
As credibility is a central bank’s most important asset, the FED has ended these purchases in March 2022 and it is expected that by this summer the ECB will be following. The FED has started to increase its short term interest rates called FED funds by 0,25% in March and as you can see in the graph below expectation is that they will continue in an unparalleled series of increases until Q1 2023. The US Government 10-year rate has jumped from close to 1,5%% since January to ca. 2,8% and the German 10-year bond rate reached 0,8%, an increase of 1,2% from its previous value in negative territory. These sharp swings in interest rates have not been seen in financial markets for decades!
What does this means for company funding in 2022?
- Liquidity conditions are tightening substantially and will continue to do so this year. Banks are facing a big pipeline of loan requests so they will tend to be selective and the all-in cost for bank loans will tend to become more expensive. Fixed-rates loans have, until now, increased more than short-term variable rates. This might change in the coming months when the FED (and possibly later in 2022 the ECB) will increase short term rates. For companies, these higher borrowing rates will be adding to the increase of other costs and salaries.
- The majority of loan requests comes from financing increased working needs, investment financing has been slowing down.
- Banks, who are already sensitive to the sector of their clients in making loan decisions, will closely follow the negative effects of this new situation on their business clients and sectors. Expect questions from your banker about the situation of your company in the current environment.
- Despite the evolution detailed above, borrowing money is still extremely cheap and advantageous for companies who can maneuver through the current situation and keep their profitability. Assuming a yearly inflation of even only 3% and a bank borrowing cost below 2%, investment projects and even a growing working capital need can still be attractively financed.
- For companies whose profit margin comes under pressure or who are facing disruption in the supply chain, banks will most probably identify the issue promptly. Our usual advice is then to pro-actively talk to your banks and discuss some flexibility in the financing, such as covenants changes and additional liquidity.