Davos, interest rates and secular stagnation

| 08-02-2018 | Lionel Pavey |


Two weeks ago there was the annual meeting of more than 2,000 politicians, business people, economists etc. at the World Economic Forum. For 4 days the most pressing and urgent topics facing the world were discussed. Sifting through all the speeches and press statements, I saw a lot of articles relating to a rather old theme of secular stagnation.

What is it?

It is a theory dating back to the 1930s stating that developed countries can suffer from a period of too small investment and too large savings. This can be the result not only of an economic recession but, more importantly, as the result of changes in the underlying demographics within a country. This would in turn imply that growth would be low to negligible within the economy. As growth slows down, so demand for investment would also slow down, leading to more savings etc.

Normal theory would demand a reduction in interest rates (the cost of money) leading to an increase in long term investments by companies, a comparative feeling of wealth amongst the people and a kick start to the economy.

Since the crisis of 2008, we have experienced an extended period of low interest rates and low inflation. The expected increase in investment, leading to improved production processes and new goods does not appear to have materialised. Furthermore, the effect that the crisis has had on individual people – job losses, house repossessions, insecurity – has made them reticent to indulge in large bouts of consumer spending.

Even with negative interest rates there has been no rush to invest in productivity. Instead funds are invested in financial assets – shares, bonds etc. Whilst offering goods returns, such investments do not add to potential economic productivity and growth in the industries that provide it.

Furthermore, when consumers tighten their belts – restricting spending and increasing savings – they are not actually directly providing funds for investment. Banks operate as intermediaries and extend credit – individual investors do not in the present system.

The economy is growing – GDP forecasts are all up among the major developed countries and inflation appears to be restrained. So have we broken the long existing chain of recognised monetary theory – could we see a prolonged period of steady growth, backed by low interest rates and low inflation?

At this stage of the proceedings an added element was thrown into the debates – demographics.

Europe is experiencing a period of shifting demographics. The long term replacement fertility rate is 2.1 children per woman. There has been a steep decline of this rate within Europe, with the rate in Germany being as low as 1.4 children. At the same time people are living longer, which means they are retired for longer. In 2006 there were 4 active workers for every retiree – by 2050 this could be down to only 2. The median age in Europe is expected to rise from 37 to 52 by 2050. EU studies have forecast that by 2050 there will be a reduction of 48 million in the working age population and an increase of 58 million in the retirees.

At the same time other studies suggest there will be a 14% decrease in working population against a 7% decrease in total population. All these projections are based on the current situation and that the trend continues.

If this was to continue, then there would be significant challenges for Europe. The expectation of governments to be able to finance the existing outstanding debt by increases in national GDP will stall. Increased burdens will be placed on the state to provide the necessary facilities to an ageing population whilst the pool of available workers is shrinking, leading to lower productivity per capita. Within the last 10 years the distribution of wealth has been skewed – there is more inequality with the super rich having proportionally even more of the total wealth than before the crisis.

New technology has the ability to change the existing concept of productivity. However, if this could be more than enough to offset the expected developments caused by an ageing population is unclear. It could mean that we are entering a prolonged period of low interest rates, low inflation and low growth. If so, all the economic models – even within companies – will need to be reappraised and a new long term policy initiated.

Lionel Pavey



Lionel Pavey

Cash Management and Treasury Specialist











The strength of the EUR or the weakness of the USD

| 07-02-2018 | treasuryXL |

There has been a significant rise in the value of the EUR in the last year compared to the USD. From a low of USD 1.05 around the end of February 2017, the EUR has climbed up to USD 1.25 – representing an increase of around 20 per cent. Analysts are talking about the price rising above USD 1.30 later this year. All very good from the EUR side, but what is causing the EUR to appear so strong and the USD so weak?

It is fairly well known that the Fed could be looking to increase interest rates in 2018 – consensus is for 3 small rises throughout 2018. As EUR interest rates are negative, initially one would expect a large movement out of EUR and into USD. But it looks as if the economies are aligned in the same way and any rise in USD rates could later be followed by a rise in EUR rates.

A lot will depend on the announcements by the ECB to taper off its QE programme. Long term EUR yields are rising in possible anticipation, but are still far behind USD yields. There is a 2 per cent yield pickup in 10 year USD treasuries over Germany who act as the benchmark for the EUR.

The posturing of the US administration and the words of President Trump appear to be having a negative impact on the value of the USD. Statements from Washington about a weaker USD being good for the US trade have impacted on the market. Trump has been very critical about trade relationships with other countries. The words being uttered by the administration are certainly having a reaction on the markets.

The Dow Jones saw a sell off on Friday – it lost more than 650 points. The job report that was published showed that the US had added 200,000 jobs in January but, despite this good news, fear is growing that this will put upward pressure on inflation, leading to further rises in treasury bond yields.

However, there are potential hazards in the future for the EUR. General elections in Italy are due to take place on the 4th March 2018. Current sentiment within Italy shows a growing negative appreciation of the EU. The trials and tribulations concerning Brexit could also seriously undermine the strength of the EUR.

Whilst it appears that the USD is weak at present, any adverse news from with the EU could lead to a swift reversal in fortunes. The underlying sentiment would imply a weaker dollar, but fundamental changes in economic policy on both sides of the Atlantic could lead to rapid changes in sentiment.


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What will be the new “normal” for interest rates?

| 23-01-2018 | Lionel Pavey |

Despite interest rate being very low for the last few years, general consensus is that rates will eventually rise – rates will become more normal. Rates are being held down by the actions of central banks with their quantitative easing. As QE is scaled backed and stopped this should allow rates to rise from their current low levels. The big question is – how high will rates rise? The Euro is not yet 20 years old and that means that whilst there is a lot of data, it does not require looking through 50 or 60 years of data to try and find the norm.

From a high of just over 5% in the summer of 2008, 10 year swap rates have fallen to a low of around 0.25% in the autumn of 2016 and are currently just under 1%. Historically, it has been usual to describe prices as moving back to around the average. However, having just under 20 years of data, it is possible to analyse the average fairly quickly.

The average rate for 10 year swaps for the last year is about 0.80%
The average rate for 10 year swaps for the last 2 years is about 0.70%
The average rate for 10 years swaps for the last 5 years is about 1.15%
The average rate for 10 year swap for the last 10 years is about 2.20%
And the average since 1999 when the Euro started is about 3.40%

The lowest rate was about 0.25% in 2016
The highest rate was about 6% in 2000

What is normal? From a personal point of view when I took out my first mortgage (back in the previous millennium) the advice I was given was that if long term fixed rates (10 years) were lower than 6.5% I should look to lock into that rate as the long term average was 7%. With every other property that I subsequently bought the long term fixed rates were lower than with my first mortgage. Currently mortgage rates for 10 year fixed are around 1.75%. Long term interest rates have been steadily falling for the last 30 – 35 years.

So, when we talk about rates eventually rising, we are still left with the problem that previous benchmarks – which were normal then – may not be applicable anymore.

A rate raise is absolute – the magnitude and its impact will be relative to our perception of the new “normal” benchmark.

Lionel Pavey



Lionel Pavey

Cash Management and Treasury Specialist


Eurozone – what to watch for in 2018

| 02-01-2018 | treasuryXL |

As we start a new year, it would be beneficial to look at matters that will possibly affect the Eurozone in 2018. It is 10 years ago that the financial crisis that started in America hit Europe and led to a global recession. This had a negative effect on GDP and it took 8 years before the Eurozone’s economy exceeded its high before the crisis. The EU is forecasting growth of 2.1% for 2018 and 1.9% for 2019. So, what are the events to look out for in 2018?

Whilst the economy appears to be growing, this recovery is still fragile and reliant on a monetary policy of low interest rates and a huge bond buying programme – QE – undertaken by the ECB. QE will be scaled back in 2018, leading to a possible halt in September 2018. It will be important to see how the markets react after the programme is stopped.

The political picture is still confusing and indecisive: in Germany a government has still not been formed more than 3 months after the elections; the referendum in Catalonia for independence and the recent regional elections have put pressure on both Spain and the EU; Italian general election in March 2018 will also add to the tension – the Eurosceptic parties appear to be growing in popularity; Greece is hoping to return to the international bond market and raise funds in the first half of 2018, but they still need to successfully exit the existing bailout programmes.

On the negative side, there is a clear difference of opinion between East and West Europe on many policies – particularly immigration – that threatens to upset the balance within the EU. Also, ambitious plans put forward by France for a Eurozone budget, will become stalled as Germany cannot commit since they have no government and Merkel is not in a true position of power to support France.

Brexit will remain a hot topic and we can expect another year of political statements. Article 50 has been enacted and there is no way back. Even though the Conservative party rely on a coalition to govern, they still have another 4 years on their current term and can negotiate from the British point of view.

Inflation shows no sign of growing – the increase in the value of the Euro against the USD and GBP should act as a brake on inflation via import prices. Pressure on wage increases is also very low – particularly within the southern part of the Eurozone, where unemployment is still very high. Interest rates also show no signs of increasing – 3 month’s futures still show a negative yield curve throughout 2018.

Quick thought – Bitcoin futures have started, but will the market really take off? The value has increased greatly in 2017, but the Bitcoin itself has done nothing productive to justify its increase in price.

In general, the outlook appears to be very steady if not spectacular. So, beware – there is always a calm before the storm!


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Eurozone economic prospect – Goldilocks meets the bears?

| 12-12-2017 | treasuryXL |

The markets and the ECB feel that the economy is doing very well. It can be compared to Goldilocks – not too hot and not too cold. Is it possible that the Eurozone could be entering a period of continued growth with little or no immediate prospect for rising inflation? A quick scan of the relevant markets would appear to suggest that it is possible. Let us examine where the markets are now.

Long term Interest rates

Long term interest rates have been in a downward channel since the summer of 2008. 10-year EUR interest rate swaps (an acceptable benchmark) peaked just above 5% in 2008 before falling and steadying around 2% towards the autumn of 2013. After a period of relative calm, the rates continued their descent to a bottom of 0.25% around 15 months ago. Over the last 3 years, 10-year EUR interest rate swaps have averaged a yield of just 0.75% – now the yield is 0.80%.

Short term interest rates

3-month Euribor turned negative in April 2015 and has remained negative. Over the last 3 years, the yield has averaged -/- 0.20% – now the yield is -/- 0.33%. 3-month Euribor futures imply that the rate will remain negative until March 2020 and, will rise to just 0.75% by September 2022.

Economic indicators

Unemployment falling to 9.6% in 2017; 9.1% in 2018
GDP growing by 1.6% in 2017; 1.8% in 2018
Government debt to GDP ratio falling to 90.4% in 2017, 89.2% in 2018
Average maturity for new government debt extending to 13 years in 2017; 9 years in 2007

So, what could happen to trigger a reversal in this sentiment?

Share prices are rising – AEX index is up almost 15% since the start of the year
House prices are rising – in the Netherlands prices have increased by 8% over the last year. Turnover is greater with 14% more homes sold than last year.
Global debt is rising – about EUR 190 trillion. This amounts to more than 300% of the world’s annual economic output. (source IIF report)
Interest coverage ratios (ICR) are deteriorating worldwide – in Europe specifically in Germany and France. (source IIF report) This, even though interest rates are low.
Balance sheet of central banks are dangerously expanded – result of Quantitative Easing.
Historical low interest rates – leading to underestimation of risks.
Political change – a rise in “populist” parties in many countries reflecting disenchanted voters

So, what about Goldilocks?

The dilemma for the ECB is that the Eurozone has, essentially, become 2 blocs – the North and the South. In the North, with increases in house prices and stock markets, and drops in unemployment; a rise in interest rates would not be deemed to be negative. However, in the South, the recovery is far behind and they welcome every form of stimulus to aid their economies.

And the moral of story – how your actions/inactions may affect others.

And remember who chased Goldilocks away – the bears (markets!)


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Saving on FX deals? Often neglected but potentially a “pot of gold”

| 21-8-2017 | Patrick Kunz |


Doing business internationally often means dealing with foreign currency (FX). This poses a risk as the exchange rate changes daily, basically every second. To mitigate this risk a company can hedge the position via FX deals (discussed in a previous article). But what are the costs of those deals to companies?


FX deals

FX is traded on exchanges where only authorized parties have access to. This can be brokers or banks, the so called market makers. They can take your fx position for a give rate and they try to find a counterparty for the deal who is willing to take the opposite trade. For this effort (and risk as they might not be able to directly match the position) they ask a provision. This is the bid-ask spread; the spread between rate for buying and rate for selling the currency. The fx (mid) rate is determined by supply and demand.

The spread depends on several things:

  • Market liquidity; how many people are buying and selling and with what volume
  • Market timing; is the market open for that currency
  • Restrictions: some currencies have restrictions

For a company to trade FX they need an account with a party that has access to fx market makers. This is often a bank. This bank will take another bite out of the spread for their profit (and maybe risk as they might take the position on their books). The spread the bank will charge depends on how many deals and how much volume you will be doing. Sometimes it is an obligation to trade with the bank from a financing arrangement. For the big currencies for big clients the spread can be as low as 2-3 pips (0,0002/0,0003).

Trading FX seems to be without costs as the bank charges no fees. However, those fees are put into the fx rate. When doing spot deals it is easy to calculate them, it’s the difference between the traded rate and the then actual market spot mid rate. When doing forward deals or trading illiquid currencies it is harder to determine the spread. Always try to get to know the spread you are paying. The spread is basically the costs of the fx deal (for forward deals there is an interest component).

It therefore makes sense to always compare your FX rates and get quotes from several banks. Trading with a broker sometimes can be cheaper as one party in the process is eliminated. Savings can be up to 5% per deal (for exotic currencies), for the bigger currencies an average saving of 1% is possible. If you do several million worth on FX deals a year this is a big money saver.

Pecunia Treasury & Finance b.v. has an online fx trading platform backed by one of the biggest worldwide fx broker.

Patrick Kunz

Treasury, Finance & Risk Consultant/ Owner Pecunia Treasury & Finance BV



2 most common financial risks faced by a company

| 16-6-2017 | Victor Macrae | treasuryXL |

You might visit this site, being a treasury professional with years of experience in the field. However you could also be a student or a businessman wanting to know more details on the subject, or a reader in general, eager to learn something new. The ‘Treasury for non-treasurers’ series is for readers who want to understand what treasury is all about. From our expert Victor Macrae we received another article on risk management, of which we thought that it adds some extra aspects to the earlier article on riskmanagement. 

An important task of a treasurer is to fully understand the financial risks that impact the firm. Two risks faced by most companies are interest rate risk and foreign exchange risk. Both risks can negatively impact the firm’s financial statements and can ultimately even lead to bankruptcy!

Interest rate risk

Interest rate risk originates from interest bearing liabilities. Most firms have loans. In the case the interest rate is variable, the interest paid varies according to an agreed market rate, such as Euribor or Libor. The risk is that the market rate will increase to a level where the firm is not able to pay its interest payments any more. In that case the firm is in default and theoretically the loan provider can request full loan redemption. In practice the loan provider is now in charge and will increase the margins on the loan as a result of the higher counterparty risk and also other charges such as fees of lawyers will be due. In order to mitigate interest rate risk a firm can use fixed rate loans or use variable rate loans in combination with interest rate derivatives such as interest rate swaps or options.

Foreign exchange risk

Foreign exchange risk occurs when a firm has subsidiaries abroad or when it transacts in a foreign currency. Suppose a firm with the euro as home currency sells products in Japanese Yen (JPY). Payment is due in three months’ time. If the JPY has weakened against the euro with 20% when the payment is due after three months, the revenues in euro are 20% lower. If the margin on the sales was 15%, then the negative foreign exchange rate change has led to a loss of 5%. Foreign exchange rate risk can be mitigated by various means, such a moving production to countries where the firm sell its products in order to match the currency of cash in- and outflows. Furthermore, derivatives such as forwards or options can be used to mitigate foreign exchange risk.

3 steps

The first step in managing interest rate risk and foreign exchange risk is to examine how the firm is exposed to these risks. The second step is to measure the impact of the volatility of interest and currency rates to which the firm is exposed on its financial statements. In the third step, if the effects are serious, the treasurer should consider which of the available options for risk mitigation best suits the firm.

Victor Macrae



Victor Macrae

Owner of Macrae Finance




Managing treasury risk: Interest rate risk (Part II)

|31-1-2017 | Lionel Pavey |


There are lots of discussions concerning risk, but let us start by trying to define what we mean by risk. In my first article of this series I wrote about risk managment and what the core criteria are for a solid risk management policy. Today I want to focus on interest rate risk. There are 4 types of interest rate risk.


Absolute Interest Rate Risk

Absolute interest rate risk occurs when we are exposed to directional changes in rates – either up or down. This is the main area of rate risk that gets monitored and analysed within a company as it is immediately visible and has a potential effect on profit.

Yield Curve Risk

Yield curve risk occurs from changes between short term rates and long term rates, together with changes in the spreads between the underlying periods. Under normal circumstances a yield curve would be upward sloping if viewed as a graph. The implication is that longer term rates are higher than short term rates because of the higher risk to the lender and less liquidity in the market for long dated transactions. Changes to the yield curve (steepening or flattening) can have an impact on decisions for investment and borrowings, leading to changes in profit.

Refunding or Reinvestment Risk

Refunding or reinvestment risk occurs when borrowings or investments mature at a time when interest rates are not favourable. Borrowings or investments are rolled over at rates that had not been forecast leading to a potential loss on projects or investments.

Embedded Options Risk

Embedded options are provisions in securities that cannot be traded separately from the security and grant rights to either the issuer or the holder that can introduce additional risk. Benefits for the issuer can include a call option, a right to repay before maturity without incurring a penalty, an interest rate cap. Benefits for the holder can include a put option, a conversion right via convertible bonds, an interest rate floor.


An attempt can be made to calculate the interest rate risk on either a complete portfolio or on individual borrowings or investment. This is done by comparing the stated interest rate to the actual or projected interest rate. Methods include:

  1. Mark to market
  2. Parallel shift in the whole yield curve
  3. Tailor-made shift in the whole yield curve
  4. Duration, DV01, Convexity
  5. Value at Risk (VaR)

These are all forms of quantitative analysis and well recognized. Personally I am of the opinion that VaR is not a very good method for interest rates. Interest rates do not display normal Gaussian distribution – they do not resemble a normal bell curve. Interest rate distribution curves display fat tails compared to normal statistical models.

Financial products that are commonly used to manage interest rate risk include FRAs, Futures, Caps, Floors, Collars, Options, Interest Rate Swaps and Swaptions.

Lionel Pavey


Lionel Pavey

Cash Management and Treasury Specialist




More articles from this author:

Safety of Payments

The treasurer and data

The impact of negative interest rates

How long can interest rates stay so low?


Treasury : proposed “to do” list for 2017

| 12-1-2017 | François de Witte |

building At the start of the year, we all look at our “to do” list for 2017. I would suggest for the corporates to focus on following topics:

1. Working capital management:

This will remain a hot topic throughout the year. The priority is to improve the financial structure by optimising the Order to Cash and Purchase to Pay cycle as well as the inventory management. A second priority is to improve the cash flow forecasting, both on the short term, to be able to improve your funding costs or the investment of the excess liquidity, and on the longer term, to improve your financial decisions. I will come back later this year on this topic.

2. Risk Management:

The general expectation is that the markets will remain volatile. In Europe, we have major elections in France, Germany, and the Netherlands. Internationally we also face uncertainties, with the impact of the new national and international policy of President Trump.

Hence, I would recommend to have an increased focus on your interest and forex risk management. You need to ensure more in particular that you have a good overall view on your forex risk, and how to manage it.

3. Technology as an enable for automation and improved controls:

The use of new technologies brings an opportunity to automate manual processes. Several solution providers have come up with smart cloud based solutions. These enable to reduce time consuming manual processes, to reduce errors and to achieve a consistency of approach, as well as greater security compared to manual processes. The increased presence of Fintech providers will enable to put in place customised solution at a lower cost. The upcoming Blockchain technology might also generate new opportunities in this area. For more information on this last point, please see: of Carlo de Meijer.

Focus areas are the automation of the order to cash process (e-invoicing, credit management), of the Purchase to Pay processes (automated match incoming invoices with the purchase orders, etc.), the incoming and outgoing payment processes, and the risk management. Automation can also help to improve the internal controls. It will enable to free time, enabling you to focus on more strategic areas, such as risk management and fraud prevention.

4. Negative interest rates:

If you are in a net debt position, the negative interest rate environment will bring you some tailwind. The opportunity is to use your cash to repay your bank debt.
However, if you are in a net cash position, the situation becomes completely different. You need to look at alternative ways to get a better return on your cash, such as supply chain financing or dynamic discounting. This requires a close alignment with your procurement department.  If your cash position remains structurally high and there are no major investment plans in the future, I would recommend to consider paying out the cash to the shareholders: “Fat capitalisation is not the closes friend of active working capital management”.

5. Fraud & cybersecurity

The only solution for both banks and corporates is to take a holistic approach to fraud as any weakness opens the door for fraud. There are simple ways to reduce this risk by putting in place strong internal controls including the segregation of duties, the dual approval for payment and other transactions, the defined list of beneficiaries and a clear policy in this area.
Durin the last year there have been many cyberattacks in treasury, and hence it is important to put measures in place to minimise the risk of similar attacks on your own business. I recommend an increased focus on computer security (regular security updates, clear policy on downloading programmes, if possible have a separate computer for online payments with special security controls, regular change of passwords).
In addition, it is important to invest in procedures and awareness raising, because cybercriminals and fraudsters almost always exploit human weakness to reach their goals. You need to ensure that the controls are embedded in the organisation

For further information, please see also the publication of Lionel Pavey.

6. Regulatory changes:

 In line with the previous years, regulatory change will continue to be a major hot topic in 2017. The focus areas for 2017 will include the implementation of the PSD2 and the impact of the BEPS project (base erosion and profit shifting) launched by the G2O and OECD. Finance and treasury teams must pay an increased attention in documenting their intercompany agreements and ensuring a market conform pricing.


 While the core priorities of treasurers continue to be on managing cash, liquidity, and risk effectively, they will have to cope an increased volatility of the markets, increased regulations and an increased risk of cyber-attacks. Technology offers opportunities to optimise your treasury management and to address these challenges more efficiently but you need also to ensure that your treasury management and controls are embedded in the organisation. Take at regular intervals time to look ahead and to make sure that you continue to travel in the right direction.


francois-de-witteFrançois de Witte – Senior Consultant at FDW Consult

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