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Interest Rates Are Rising: Lock In Rates Now with IR Hedging

The Federal Open Market Committee (FOMC) is set to meet on May 4, 2022 – and it’s looking like the fed funds rate will rise (again).

Market participants are being hit with a trifecta of complications that are causing uncertainty:

  1. The SOFR transition
  2. The geopolitical uncertainty
  3. The current rising interest rate environment to combat inflationary pressures

We’re seeing larger than usual variances in interest rate forward curves (depending on modeling/provider/counterparty). Changes in liquidity between risk-free rates vs. -IBORs, reduced liquidity in Eastern Europe, and impacts on commodities like wheat and nickel are all contributing to increases in volatility across the board.

In this blog, we’re focusing on one piece of this volatility: the interest rate environment. First, let’s recap where we’re at in the market with interest rates.

2022 Fed Funds Rate Activity

During its March 2022 meeting, the FOMC raised the target for the fed funds rate by a quarter-point to 0.5% – the first interest rate increase in three years. The FOMC signaled ongoing rate hikes ahead, with the fed funds rate expected to reach 2% by the end of 2022.

So, what does this mean for corporations and financial institutions?

How Rising Rates Impact Your Organization (& What You Can Do About It)

Corporates

For corporate borrowers, rising rates will increase your interest expense on variable rate debt. This means, if you haven’t already, now is the time to set up a hedge program with the goal of locking in today’s rates before they further rise.

You can do this by using a pay-fixed, receive-variable swap. This provides interest expense predictability, so your core products and services prices are not at risk.

Financial Institutions

 For financial institutions, rising rates can create a mismatch between your long-term fixed-rate investments (like mortgages) and your short-term floating-rate liabilities (like money market accounts and certificates of deposit). This mismatch between fixed-rate assets and floating-rate liabilities can cause unwelcome earnings volatility.

To minimize this volatility, you can do two things:

  1. Hedge the short-term liabilities with cash flow hedging of the contractual rate.
  2. Use the new portfolio method for fair value hedging to hedge a closed portfolio of fixed-rate assets.

Either way, you can lock in your spread by either increasing the tenor of your liabilities or decreasing the tenor of your assets.

Conclusion

The interest rate environment – and broader market volatility – has market participants wondering what they can do to stabilize their operations. If you want to lock in rates now before they get even higher throughout the year, you can do that with hedging. But don’t worry, you don’t have to do it alone.

We work with corporates from the start of the hedging journey through accounting and disclosures. We also help with:

  • Board education
  • Trade design and negotiations
  • Designation documentation
  • Effectiveness testing design and execution
  • Monthly accounting and management reporting
  • Quarterly effectiveness assessments and disclosure reporting

For financial institutions, we provide much of the same support, including:

  • Board education
  • Trade design
  • Designation documentation
  • Effectiveness testing design and execution
  • Monthly accounting and reporting
  • Quarterly effectiveness assessments and disclosure reporting

Ready to get ahead of future interest rate hikes? Contact us to learn how we can work together.

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