The volatility in the equity markets flowed over into the interest rate markets Monday following concerns that the Fed may slow the pace of rate hikes.
The counter argument - that the strength of the underlying economy warrants even faster rate hikes to contain potential inflation driven by the low unemployment rate and rising wages – subsequently caused a pullback. Interest rate option volatility, still at historic lows, has also spiked up slightly.
• The changing environment should impact your hedging strategy decisions.
• For the first time in nearly a decade, there is two-way risk in the interest rate market, and while the general trend is for rates higher, there will potentially be short-lived opportunities to hedge at relatively more favorable rates.
• For anyone with unhedged interest rate exposures, this week was probably one of those opportunities. Being prepared to move quickly in these situations is key.
• Those who use high strike ‘disaster caps’ (the cheapest hedge strategy for the past decade) should consider moving strikes down to more moderate levels unless the business and returns can truly withstand higher rates.
A more thorough evaluation of swaps vs. caps is in order, as changes in the Fed mode, option volatility, and yield curve steepness all impact relative performance.
Our Interest Rate Hedge Dashboard helps to quantify these factors so if you’d like to receive it, or would like JCRA to look at hedging opportunities for you, please email or give us a call