Global investment firm KKR has warned that central banks globally will start tightening this year and expressed caution on long-duration government bonds, over-levered 2021 vintage deals, lower-income consumer exposure, and assets dependent on the return to the old regime of low inflation, low rates, and abundant liquidity, according to its mid-year outlook report 'The Divergence Conundrum'.
Central Bank Policy Shift
The report said that the global easing cycle is fading, and central banks may stay restrictive for longer, as inflation proves stickier and growth more resilient than expected. "The easing cycle is fading, and the next debate may be more about how long policy stays restrictive," said Henry H McVey, head of global macro and asset allocation at KKR. He added, "Inflation headwinds will also likely stay a bit higher for even longer, and central banks could be more restrictive than originally thought."
Leveraged Deals Under Pressure
KKR flagged multiple areas of caution for investors, particularly over-levered deals from the 2021 vintage. These transactions, struck during a period of ultra-low rates and abundant liquidity, now face a higher cost of capital as central banks tighten. The report also highlighted lower-income consumer exposure as a risk area, given persistent inflation eroding purchasing power.
Treasuries: A Less Reliable Safe Haven
On government bonds, the report stated, "In our view, long-duration treasuries have become a less reliable safe haven since the onset of Covid." This caution is significant for trade finance professionals who rely on risk-free rates for pricing and hedging. As treasuries become less stable, hedging costs may rise and yield curves may steepen, affecting the cost of capital for trade finance.
Implications for Trade Finance and Business
The tightening cycle signaled by KKR has direct implications for trade finance. According to the report, central banks staying restrictive longer means higher borrowing costs for businesses financing cross-border trade. Trade finance professionals should expect increased margins on letters of credit and supply chain finance as banks pass on higher funding costs. Additionally, the caution on long-duration treasuries suggests that FX hedging strategies using these instruments may become more expensive and less effective.
| Risk Area | KKR's Caution | Business Implication |
|---|---|---|
| Long-duration treasuries | Less reliable safe haven | Higher hedging costs, increased volatility in risk-free rates |
| 2021 vintage leveraged deals | Over-levered, higher refinancing risk | Higher defaults or restructuring in leveraged trade finance |
| Lower-income consumer exposure | Pressure from sticky inflation | Reduced demand for imported consumer goods, smaller trade volumes |
The report signals a clear shift in global monetary policy this year, urging CFOs and treasury directors to reassess their debt structures, duration exposure, and hedging programs. With central banks potentially more restrictive, the cost of trade finance is likely to rise, while the reliability of traditional safe assets diminishes.
Henry H McVey’s warning that “inflation headwinds will also likely stay a bit higher for even longer” reinforces the need for businesses to lock in financing terms now, before rates climb further. The divergence conundrum – between resilient growth and stubborn inflation – will be the defining theme for trade finance professionals in the coming quarters.
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