Daily Management Review

Wall Street Banks Evaluate Risks And Opportunities Of Rising US Inflation At 31-Yr High


Wall Street Banks Evaluate Risks And Opportunities Of Rising US Inflation At 31-Yr High
Wall Street banks are preparing for a prolonged period of higher inflation by conducting internal health checks, checking whether clients in vulnerable industries can repay loans, developing hedging measures, and advising prudence when it comes to transactions.
Consumer prices in the United States increased by the most in 31 years this month, owing to increases in the cost of gasoline and other commodities. find out more
Senior bank executives are becoming less convinced by central bankers' claims that the surge is a one-time blip due to supply chain disruptions, and are increasing risk management.
Inflation is often viewed as a good for banks, as it increases net interest revenue and profits. However, senior bankers caution that if inflation rises too rapidly, it might become a drag.
Inflation, according to Goldman Sachs Chief Operating Officer John Waldron, is the most serious threat to the world economy and stock markets.
Last month, JPMorgan Chief Executive Officer Jamie Dimon warned analysts that rising inflation and high-interest rates raise the potential of dramatic price fluctuations and that banks "should be concerned."
According to one senior banker at a European bank with significant U.S. operations, a protracted period of higher inflation would pose credit and market risk to banks, which they are examining in internal stress tests.
Another banker said risk teams are also keeping an eye on loan exposures in the industries most hit by inflation. Companies from the consumer discretionary, industrial, and manufacturing sectors are among them.
"We are very active with those clients, offering hedging protections," said the banker, who asked not to be named as client discussions are confidential.
Clients who may want additional cash to get through a period of rising inflation are encouraged to raise capital while interest rates are still low, according to the banker.
"It's still a very beneficial environment to be in if you need funding, but that won't last forever."
Higher inflation and monetary tightening are also being considered by investment bankers as potential disruptions to record transactions and public offering pipelines.
"We expect a sustained period of higher inflation, and monetary tightening could slow the momentum in the M&A market," said Paul Colone, U.S.-based managing partner at Alantra, a global mid-market investment bank.
"Evaluate the risks prolonged inflation might bring to both value and business outcomes," Colone said. Alantra advises clients in the early phases of M&A conversations to "review the risks sustained inflation may bring to both valuation and business results."
Meanwhile, sales and trading teams are receiving increasing calls from clients trying to restructure portfolios that are at risk of losing value. When inflation became uncontrollable in the 1970s, stock indexes in the United States took a beating.
"We're seeing more interest from clients in finding some manner of inflation protection," said Chris McReynolds, Barclays' head of U.S. inflation trading.
Inflation in the Treasury Protected Securities, which are issued and backed by the US government, are becoming increasingly popular, according to him. The securities are comparable to Treasury bonds, except they are inflation-protected.
Traders are also witnessing an increase in demand for derivatives that provide inflation protection, such as zero-coupon inflation swaps, which exchange a fixed-rate payment on investment for a payout based on the rate of inflation.
"People are realizing they have inflation exposure and it makes sense for them to hedge their assets and liabilities," McReynolds said.