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SME’s guide to surviving treasury yield curve recession

What you’ll learn

  • Learn how the treasury recession impacts SMEs.
  • Identify the telltale signs of the impending treasury yield curve recession.

What is the treasury yield curve? 

The relationship between yields and maturities of on-the-run treasury fixed-income securities is depicted in a line chart by the treasury yield curve, commonly referred to as the term structure of interest rates. It illustrates the yields on treasury securities with set maturities, such as 1, 2, 3, 5, 7, 10, and 30 years. As a result, they are often referred to as CMTs (Constant Maturity Treasury Rates).

Types of treasury yield curves

There are three main types of yield curves in treasury. They are explained as follows: 

  1. Normal yield curve: A normal or upward-sloping yield curve indicates that yields on longer-term bonds may continue to climb in response to times of market volatility. Thus, a typical yield curve begins with low rates for bonds with shorter maturities and rises for bonds with longer maturities, sloping upward. As longer-term bonds often have a larger yield to maturity than shorter-term bonds, this is the most typical type of yield curve.
    Normal yield curve
  2. Inverted yield curve: An inverted yield curve slopes downward and indicates that short-term interest rates exceed long-term interest rates. This type of yield curve is associated with downturns in the economy when investors anticipate further declines in yields on bonds with longer maturities. Furthermore, during a downturn in the economy, buyers looking for secure investments prefer to buy these longer-dated bonds over short-dated ones, driving up the price of long bonds and lowering their return.
    Inverted yield curve
  3. Flat yield curve: A flat yield curve is characterized by similar yields across all maturities. There may be a few intermediate maturities with marginally higher yields, which results in a small hump along the flat curve. These hurdles typically affect mid-term maturities between six months and two years.

    The term “flat” refers to the lack of significant variation in yield to maturity between shorter-term and longer-term bonds. A yield curve that is flat or humped indicates an uncertain economic condition. It might occur near the end of a period of rapid economic expansion that is causing inflation and concerns of a yield curve inverted recession.

    Flat yield curve

What does a yield curve inversion indicate in the economy? 

The yield curve is inverted when short-term interest rates are higher than long-term interest rates. Since debt with longer maturities often bears higher interest rates than debt with shorter maturities, the yield curve usually is not inverted. An inverted yield curve is a notable and unusual economic occurrence since it indicates that the short term is riskier than the long term. The market volatility formed as a result is a yield curve inverted recession or treasury yield curve recession. 

How does it help SMEs?

The yield curve rarely inverts, and when it does, it might indicate an impending economic slowdown or yield curve inverted recession. Treasurers can refer to the yield curve to understand how the interest rates are acting and whether a treasury recession is on the horizon, helping SMEs spot a treasury recession. It helps them create cash buffers and prepare for future cash crunches by forecasting and analyzing the fluctuation of interest rates.

How to fortify yourself against treasury yield curve recession with best practices?

Accurate monitoring, management, and forecasting of cash flows give treasurers essential insights into a company’s strength, profitability, and long-term prospects. This proves to be especially useful during market volatility by helping identify idle cash and cash shortfalls and helps in properly allocating financial resources. 

Some of the best practices to follow to safeguard your organization against treasury yield curve recession are:

  1. Evaluate signs of an economic slowdown: A yield curve inverted recession cannot be foreseen in a single method or at a single time. Numerous economists claim there are two well-known indicators:
    1. Leading indicators: Any measurable or observable variable of interest that foretells the appearance of a change or movement in another data series, process, trend, or other phenomena of interest is referred to as a leading indicator. Although every company monitors its profit margin and balance sheet, the information in these reports is a lagging signal. An organization’s past success does not ensure its future success. Instead of using past performance measurements as forecasters of future revenues, growth, or profitability, organizations can instead use metrics such as: 
      1. DSO lengthening
      2. Drop in customer credit score
      3. Payment terms pushback
      4. Partial payments
    2. Lagging indicators: A lagging indicator is an observable or quantifiable variable that changes after the changing of the correlated economic, financial, or business variable. Lagging indicators give more insights than the leading indicators since many leading indicators are usually unstable, and short-term fluctuations can conceal turning points or result in misleading signals. An example of a lagging indicator is past due A/R. 
  2. Utilize scenario planning in cash forecasts: Decision-makers may manage many scenarios, review actions, and anticipate potential outcomes and implications using scenario planning. Due to inadequate scenario planning with spreadsheets or subpar technology, businesses abruptly overborrow with exorbitant interest. They could incur significant debt, incurring fees for making loan payments past due. By taking into account numerous customer and invoice-level data, automated cash forecasting assists in correctly predicting the payment dates for each customer. When creating a cash flow projection, treasurers can also consider external factors such as changes in raw material prices to capture patterns. 
  3. Perform frequent cash forecasting: Regular forecasting involves developing precise and updated forecasts using available historical and current data. It enables treasury to base choices on the firm’s current state rather than a potential budget determined months in advance. If businesses frequently undertake cash forecasting, they can anticipate future financial shortfalls and prevent missing payments. Companies can take remedial actions with the help of a real-time cash flow projection, such as:
    1. Improving payment and collection techniques
    2. Selling assets
    3. Approaching lenders 

    It provides them with the crystal-clear vision they need. It allows for performing variance analysis over a range of time periods across regions, companies, and cash categories. Additionally, it offers the ability to dive deeper into variance reasons for more effective cash flow control.

  4. Optimize treasury management methods: Guiding principles for optimizing treasury management with treasury automation include the following:
    1. Centralized treasury and frequent cash flow forecasting:
    2. Consolidating the treasury function under one centralized structure can help managers with an aggregate perspective of their cash flow and risk positions, which is required to optimize debt and investment portfolios and minimize taxes and financial risk. Frequent cash flow forecasting helps increase the accuracy of forecasts and ensures that treasurers have the most relevant reports on which to base their decisions. Regular forecasting and a centralized treasury help mitigate risks during treasury yield curve recession. 

    3. Reporting with real-time data:
    4. An effective treasury management service evaluates a company’s success. A treasury module integrated with ERP or a standalone treasury management solution provides the precise reporting backed by data insights required to make business decisions amid market volatility and a treasury recession.

    5. AI and automation adoption:
    6. Treasury automation decreases manual labor and frees teams to focus on key objectives. And AI uses and processes more data, so forecasts become more accurate, which improves liquidity and debt management. It also provides crucial information for other organizational components such as supply chain management and financial planning. Additionally, it aids companies by lowering complexity and operational risk.

Learn in depth how to manage the treasury yield curve recession with treasury automation.

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The HighRadius™ Treasury Management Applications consist of AI-powered Cash Forecasting Cloud and Cash Management Cloud designed to support treasury teams from companies of all sizes and industries. Delivered as SaaS, our solutions seamlessly integrate with multiple systems including ERPs, TMS, accounting systems, and banks using sFTP or API. They help treasuries around the world achieve end-to-end automation in their forecasting and cash management processes to deliver accurate and insightful results with lesser manual effort.