Chatham's 2022 outlook: Inflation, COVID-19, and capital markets trends
What are some of the macroeconomic trends we are seeing as we enter 2022?
We are entering a year of a lot of unknowns. We see markets are functioning well, companies are hitting their earnings goals, labor is in demand, and we don't have high unemployment. Alternatively, we are watching the omicron variant and its impact on the markets, as well as the repercussions of ending fiscal stimulus, student loan repayment deferrals, and expiring child tax credits. Inflation could also become problematic for us this year. One dilemma we're seeing with inflation right now is the negative real rates in the economy. With Treasury rates where they are and TIPS yields where they are, the actual capital markets are pricing in inflation over the next 10 years of about 2.5%, which is far lower than where we have seen inflation in the third and fourth quarter of 2021 in the U.S.
The capital markets suggest that inflation is going to decrease significantly because of a combination of ending fiscal stimulus, along with a more aggressive monetary policy to fight inflation. We recently saw the Bank of England raise its interest rates, and the Fed has signaled that there will be three interest rate increases in 2022. For our clients, and for any users of debt or derivatives products, this is as an indicator that there could be a rise in interest rate volatility.
How has COVID-19 and The Great Resignation impacted the markets?
COVID-19 continues to affect our markets in two fundamental ways. First, there's the underlying virus and its impact on health. Second, there is the impact on how governments and organizations react to the virus. This pandemic has also contributed to The Great Resignation, where millions of professionals left the workforce. Several firms are now turning more toward outsourcing and automating different roles in their organizations as they question how many employees to have on their own payroll. We believe this trend will continue for the next few years.
Several firms are now turning more toward outsourcing and automating different roles in their organizations as they question how many employees to have on their own payroll.
What are the specific trends we are seeing with clients in the broader capital markets?
For some of our clients, reliance on floating-rate debt was greater in 2021 than we've seen in past years. Underlying that presumption was that short-term interest rates would stay low for a long period. There's now a large fear of interest rate volatility as we come into 2022, and we're seeing increased amounts of long-term hedging or increased use of fixed-rate issuances.
How have organizations been addressing interest rate volatility?
We spent the second half of 2021 working with our clients to address interest rate volatility and to help prepare their organizations for any new market. While we don't have a firm view as to exactly where interest rates will be at the end of this year, we believe that interest rate volatility can be harmful to most companies. The prudent use of fixed-rate debt and hedging is a way to shield from the negative impacts.
The prudent use of fixed-rate debt and hedging is a way for companies to shield themselves from the negative impacts of interest rate volatility.
Are there items to monitor in 2022 regarding the LIBOR transition?
While we've come a long way in our transition away from LIBOR, we haven't answered all the questions as it relates to other benchmarks such as SOFR and SONIA, and how debt will be priced, how liquid the markets will be, and how the markets will function with the use of multiple benchmarks.
What's next for Chatham and our clients?
As we expand our footprint and how we serve capital markets and our clients, we're going to find that some principles will remain the same. Our deep capital markets expertise, along with our client relationships, will continue to be fueled by our knowledge, data, and tools. Our ability to harness and to see a large part of the capital markets, coupled with our willingness to use technology to solve problems, put us in a position to serve our clients well and enable them to make the best possible decisions in the capital markets.
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Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.21-0350