Hedging costs update — November 8, 2021
Summary
The Fed has started tapering its purchase of bonds, signaling a potential end to quantitative easing (QE). This has occurred in the context of a market that has pulled forward expected timing for a rate hike from the Fed. These factors have driven a rapid increase in hedging costs, particularly interest rate caps.Key takeaways
- On Wednesday, November 3, the Federal Reserve announced that they would begin the process of their QE tapering, cutting bond purchases by $15B monthly from their current pace of $120B/month.
- This largely anticipated action marks a move toward a less accommodative stance by the Fed and caps a month that saw short-term rates almost double as the market pulled forward timing for a rate hike from the Fed.
- In the context of this rate environment, interest rate cap costs have increased substantially, the second such notable move this year.
Tapering has always been viewed by the market as a necessary precondition for the Fed to begin raising rates. While the Fed has cautioned that tapering should not be viewed as a signal that the Fed is preparing to raise rates, it has occurred with the backdrop of a market that has pulled forward its expected timing for rate increases, particularly as concern has mounted over the past month that supply chain pressures and energy prices would drive inflation to be more than “transitory”. As of close of business Thursday, Fed Fund futures imply a greater likelihood than not of a hike coming in June of 2022 and a second by November the same year.
Target rate probabilities (bps)

Source: CME Group
SOFR forward curves

Indicative cap pricing (bps on loan amount)

SOFR swap rates

If you’d like to understand any of these approaches better, please reach out to your Chatham representative to discuss further.
Contact a Chatham expert
Reach out to the Chatham team to discuss the recent increase in hedging costs
Disclaimers
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.
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