As expected Warriors win, Fed hikes

By Kevin Holme, Managing Director, Capital Markets

Discover how businesses can manage interest rate risk and expense in light of the Fed's action.

As widely expected, the Federal Reserve (Fed) raised the Federal funds rate to a range of 1.00 percent to 1.25 percent on June 14, 2017. This was the third consecutive quarterly rate hike, and the fourth since the Fed started its tightening cycle back in December of 2015, after nearly a decade of driving rates down to essentially zero. The market was fully pricing and expecting today’s rate hike, and the odds of a hike have been high for several weeks.

As we have previously cautioned, the Fed remains measured in its response and data dependent as it tries to normalize monetary policy after years of easing. Again, we note that economic growth in this cycle has continued to be weak, averaging only around 2 percent. Weak productivity gains, tepid wage growth and reductions in capital expenditures continued to drag on the economy. In addition, inflation has yet to climb above the Fed’s targeted level of 2 percent.

Perhaps the most interesting news today is the Fed's statement about its intentions going forward regarding future hikes and the size of its balance sheet. The Fed maintained its outlook for an additional 25 basis point rate hike in 2017, and set out some details for how it plans to gradually reduce its $4.5 trillion holdings of Treasuries and mortgage securities. While Chair Yellen did not give any clues as to exact timing of these events, they will most likely occur in the fourth quarter of 2017. In addition, the Fed reaffirmed another three quarter point rate hikes in 2018; its medium forecast for the terminal rate in 2019 dropped to 2.9 percent from 3.00 percent from its March forecast. As is generally the case, the Fed kept its options open to modify these plans depending on economic activity.

It has been somewhat surprising to many analysts that long-term rates are trading near their lows for the year. The 10-year Treasury rate is down about 20 basis points over the last 30 days and down almost 50 basis points since its high for the year of 2.63 back on March 13, 2017. Further, market volatility has been surprisingly low—particularly so given the undercurrent of political and geopolitical instability both domestically and globally (think UK elections, turmoil in Washington, ISIS, the Korean Peninsula, and on and on).

Accordingly, with long-term rates still at historic lows and short-term rates continuing to edge higher, market conditions today offer borrowers extremely well-priced hedging vehicles to control interest risk and preserve great flexibility. We advise our clients to consider alternatives that span beyond the normal fixed rate swaps and loans. These include interest rate caps, collars, and swaps that have embedded cancellation options to provide maximum flexibility, optionality and protection where the rate outlook continues to be uncertain.

For further discussions on how MB can help your business navigate the rate environment going forward, contact your relationship banker or give us a call directly.