In the face of ongoing volatile conditions in the market, businesses of all sizes and sectors continue to look for ways to weather the swirling macroeconomic headwinds. High inflation, rising interest rates, supply chain disruptions, labor shortages and diminished liquidity are all coming together to create what may feel like the perfect storm.  

Amid such volatility, it may be easy to lose sight of an important reality: We’ve been here before, and we know it’s temporary. History bears out that the economy is cyclical. Roughly every ten years, dating back to the Great Depression, the economy has faltered. The downturns are usually measured in months, not years, the time between downturns is similar – and the economy always rebounds.

Seismic Shift in Monetary Policy

Recent inflation headlines have many investors on edge. As investors, we constantly challenge our own thinking and question when a transitory inflationary period may evolve into something different. In this instance, however, we believe high inflation is a confirmation of an accelerating expansion phase in the business cycle and investors should remain constructive on the market outlook. Our outlook is predicated on two primary objectives: containing COVID-19 and a reacceleration of global earnings revisions. Third-quarter earnings season is underway, and revisions thus far remain positive. We believe inflation pressure from supply chain bottlenecks stem from labor shortages due to the pandemic. PNC Economics expects to see further progress in the labor market in the coming months, which should continue to alleviate near-term supply chain shortages. We continue to keep a close eye on market indicators but believe markets are priced for a long-term recovery from last year’s recession.

The current volatility comes on the heels of the longest expansion in U.S. economy history, and then a very strong rebound from the deep but short pandemic-induced recession, which may contribute to the shock some in the market are feeling. For the majority of the last ten years, the Federal Reserve has employed Quantitative Easing (QE), a monetary policy designed to increase domestic money supply and catalyze economic activity. In addition to lowering interest rates to as low as 0%, the Fed increased its balance sheet to nearly $9 trillion, buying long-term assets and injecting massive amounts of liquidity into the economy. The overall result was low short-term and long-term interest rates, appreciation across a variety of asset classes, solid GDP growth and decades-low unemployment rates – all intended outcomes of QE.

QE was successful in pulling the economy out of the Great Recession and then the COVID-19 recession, but sustained monetary stimulus has contributed to the highest inflation in 40 years. The current Fed response to curbing policy excesses is not only to discontinue QE, but to reverse it with a stiff headwind in the form of Quantitative Tightening (QT). This, in turn, makes an economic downturn in 2023 more likely than not.

The Fed’s approach to fighting inflation centers on raising both short-term and long-term interest rates to reduce consumer and business borrowing and cool off economic growth. QT – reducing the size of the Fed’s balance sheet by not replacing maturing securities – has led to much higher long-term interest rates. For example, the typical interest rate on a 30-year mortgage has increased from below 3% in September 2021 to almost 7% at the end of 2022. In addition, the Federal Open Market Committee has been raising short-term interest rates at a record pace. At the start of 2022, financial markets expected the FOMC to raise the fed funds rate, their key short-term policy rate, by around 25 basis points this year. This proved to be a vast underestimate, as the Fed has raised the rate by 425 basis points in 2022, with more hikes projected in 2023 – a clear indication of the Fed’s commitment to utilizing monetary policy, including QT, to push inflation back to the central bank’s 2% objective.

What is important to keep in mind during such drastic shifts, in the view of PNC economists, is that they are temporary. QE and QT are policies the Fed implements with the goal of returning the economy and financial markets to states of equilibrium. Until this occurs, strong financial partnerships are going to be key for businesses to navigate the volatility. 

Finding Solutions in a Challenging Liquidity Environment

Adopting a sound financial strategy takes on added importance given the current economic environment and interest rate landscape. An upside to the rising rate environment is that, while borrowing costs are higher, so are rates on interest-bearing liquidity solutions. A financial institution that provides such solutions, as well as options that accommodate risk tolerance, can play a significant role in helping businesses manage cash effectively.   

“It’s particularly important in a rising rate environment for businesses to evaluate their liquidity framework and potential risk exposure,” said PNC Product Advisor Dan Petrilla. ”Effective liquidity management should include cash forecasting and segmenting cash into operating, strategic and reserve categories.”

According to Petrilla, if operating cash is essential on a daily, weekly or monthly basis, non-interest-bearing checking accounts or sweep solutions may provide a good fit. For reserve cash needs, options ranging from interest-bearing accounts to fully automated sweep solutions can be effective cash management tools, depending on how much cash is needed for day-to-day operations. When it comes to long-term strategic cash, businesses should consider a range of options for maximizing yield while keeping risk top of mind. Most important of all, businesses need to continue to reevaluate their approach every time interest rates or market conditions change.

“Needs are going to change as market conditions change,” said Petrilla. “Businesses stand to benefit the most by partnering with a bank that can offer a fully customizable liquidity continuum, regardless of the rate environment.”

Ready to Help

PNC can work with you to develop strategies to help you manage issues related to market volatility and liquidity solutions. For more information, reach out to your PNC Relationship Manager, or click here to contact us.