Summer is well and truly here, but those hoping for a lull have been sorely disappointed. Almost wherever you look – be it at deal flow, central bank policy, or political risk – it is clear that the weather is not the only thing heating up.
Setting aside the threat of a global trade war that looms over equities, the main theme for UK markets this quarter was the apparently imminent raising of the Bank Rate by the Monetary Policy Committee, which will put it above 0.5% for the first time in nearly ten years. Readers complaining that this has been ‘apparently imminent’ since Mark Carney took up his post in 2013 are of course correct. In the last three months alone, the governor has already U-turned once, spending April guiding towards a rate hike at the May meeting before rowing back on this in the face of lacklustre Q1 inflation and GDP figures. Nevertheless, markets remain convinced that this time is different, pricing in a Bank Rate of 0.75% at the August meeting with around 80% probability.
Whether or not the MPC follows through, the fact remains that the GBP, USD, and EUR are now in very different interest rate regimes. As a result, it is both more important and more difficult than it has been for some time for companies to ensure that they are choosing the optimal currency split for their debt. Matching the currency mix of the debt to that of EBITDA has long been a key component of the natural hedging toolkit, allowing companies with overseas revenues to stabilise both equity value and leverage ratio in the face of foreign exchange movements.
The current prevalence of private lenders willing to extend multicurrency facilities makes this particularly easy, but considerations around interest rate differentials are key. A European company with US revenues may wish to draw USD debt to reduce its FX risk – but there comes a point where the increased funding cost outweighs the benefit. Determining where this line should be drawn has been a crucial topic for our clients in recent months.
On the acquisitions side, deal-contingent hedging continues to grow in popularity – driven in equal parts by the increased FX risk associated with cross-border M&A deals as a result of political tensions, and by an ever maturing market for solutions.
Looking ahead to the second half of the year, it seems fair to say that – after an all-too-brief sojourn in which markets took their lead as they should from fundamentals – political headline risk will be back in the driving seat. With the issues at stake including the conclusion of the Brexit negotiations; the survival (or not) of several of the governments conducting them; and the resolution (or not) of the developing trade war between the US and China, the one thing we can say for certain is that the investment environment will remain interesting!