Bracing For Inflation This Coming Year
Across the spectrum of business leadership, all stakeholders have had to take their business strategy more seriously than ever in the past couple of years. The pandemic has brought a number of challenges, among them being inflation. The majority of federal reserve presidents, economists, and business leaders agree and expect that the larger than normal costs and inflation experienced in recent quarters will unfortunately continue through the next year or so.
Such expectations are alarming, to say the least. The answer to scaling the mountain that is 2022’s inflation lies in a sound comprehension of what the circumstances will be in the coming year, in addition to taking specific measures that traditionally have aided organizations well during times of inflation, but also (more importantly) actions that address the idiosyncratic adversity we have faced for the past two years.
Anticipated Difficulties in the Coming Year
In the same 4th quarter CFO Survey mentioned above, less than 20% of CFOs in a recent survey stated that they expect cost increases to diminish within 6 months. Instead, a whopping 60% of them anticipate that the cost increases will last at least another 10 months, if not into 2023. In addition to finance leaders surveyed, almost 90% of the firms surveyed report larger-than-normal cost increase, this being a sharp rise from the second quarter of 2021.
Economists forecasted closer to average inflation of about 2.7% in 2022, down from the expected 6.6% at the end of 2021. Higher inflation forecasts may push the Federal Reserve to raise short-term interest rates next year instead of waiting until 2023.
In response to the anticipated rising costs, the finance leaders surveyed stated they are pursuing two strategies. Roughly 80% of the CFOs are looking to pass on at least some of these cost increases to customers through higher prices. More than a third of the respondents say they are passing through 76% to 100% of the higher costs.
A lower proportion of firms report absorbing cost increases, reducing costs in other areas, including reducing margins, eliminating or substituting product offerings, adding contingency clauses into contracts, and turning down work. Cost pressures and inflation was the second-most pressing concern among CFOs in the fourth quarter, outpaced by the availability and quality of labor. Supply-chain disruptions came in third. Fewer CFOs are concerned about customer demand and tax policies than last quarter. Still, many firms anticipate employment and revenue growth in 2021 and 2022, accompanied by continuing increases in employees’ wages.
Being a Proactive Finance Leader in Light of Inflation
Although the aforementioned two strategies are not bad approaches to the oncoming inflationary issue, there are a few specific actions that traditionally have worked very well for a number of CFOs in difficult circumstances such as this. They are as follows:
1. Learn From the Pandemic:
This of course is an action new and unique to the current era. During a pandemic, bouts of inflation and other times of instability, CFOs should exemplify “agile absorption,” or the ability to swiftly seize opportunities while maintaining structural strengths such as a solid balance sheet.
It’s easy to freeze up and become a deer in the headlights in the face of unprecedented turbulence. But the real competitors will be proactive and fully adjust to their adverse circumstances. A number of organizations have succeeded in this sense by increasing their corporate agility. This was due to their sound interpretation of the future, quality data collection, and integration of innovative new technologies that empower companies to better perform the former two tasks.
The sudden, unexpected onset of COVID-19 underscored to CFOs the value of agility, an essential trait when prices surge.
2. Issue Debt
Given the fact that the benchmark 10-year Treasury note today yields about 1.6%, CFOs should take advantage of low borrowing costs and sell debt.
“This is a good time to lengthen the maturity of your debt as much as possible and to think about issuing debt,” said Charles Calomiris, a Columbia Business School Professor. Inflation over time will reduce real servicing costs.
“It doesn’t mean you go crazy and issue debt you can’t repay,” said Calomiris. “But it does mean you cross a little bit more in the direction of selling more debt of longer maturity.”
3. Purchase Services and Goods at Today’s Prices
Given the reality of inflation’s ability to severely erode purchasing power, CFOs should consider buying the goods and services that they anticipate needing in the future now, instead of putting such purchases off until they become exponentially harder.
A CFO needs to weigh the expected price increase against the cost of financing and carrying extra inventory. Such a strategy flouts a decades-long emphasis at many companies in slimming inventories in order to free up cash.
4. Cushion Your Company’s Portfolio
CFOs should consider moving a portion of their company investment portfolios into inflation buffers such as gold, Treasury Inflation-Protected Securities (TIPS) and funds that track the prices of a basket of commodities.
Financial executives should also remember that no investment is a perfect inflation hedge. Gold pays no yield and the prices of oil and other commodities can be highly volatile and vulnerable to geopolitical tensions. Diversification is essential.
5. Hedge Against a Falling Dollar
CFOs at companies that heavily depend on imports may want to consider using a currency swap or similar financial tool to limit losses from depreciation of the dollar. A financial executive would need to take into account transaction costs and ensure the second currency is also not vulnerable to inflation.