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Article

Hedging in today's flat-to-inverted yield curve environment

Date:
February 18, 2020
  • kevin jones headshot

    Authors

    Kevin Jones

    Director
    Treasury Advisory

    Corporates | Kennett Square, PA

Summary

Today's flat-to-inverted yield curve represents an opportune time for companies with floating interest rate risk to lock in a level of certainty at a favorable rate.

Tracing a flat-to-inverted forward path, the current USD LIBOR forward curve seems to contradict most U.S. economic indicators: While unemployment remains low and job growth continues steadily, the forward curve implies more economic consternation than the indicators would suggest. Instead, the markets are pricing in broader global economic concerns, such as growth slowing in China and the impact of trade tensions. Regardless, the curve represents an opportune time for companies with floating interest rate risk to lock in a level of certainty at a favorable rate. Whether the considerations are hedging floating rate debt, anticipating a bond issuance, or debt refinancing, many companies are taking advantage of this unique moment in the financial markets.

Graph of swap rates showing flat to inverted yield curve

Tracing a flat-to-inverted forward path, the current USD LIBOR forward curve seems to price in more economic consternation than the indicators would suggest.

Hedging floating-rate debt

For companies with floating-rate debt, hedging has always been a mechanism to introduce more certainty. In today’s environment, given the shape of the curve you may be able to lock in a swap rate that is at or below current LIBOR fixings. As you think broadly about your mix of fixed- vs. floating-rate debt, consider taking the opportunity to increase your share of fixed-rate debt, achieving your targeted ratios by entering into swaps.

Forward hedging fixed-rate debt

Concurrent with the move towards fixed-rate debt, bond issuance has also become attractive given the lower overall rate environment. If your organization has a moderate level of certainty surrounding the likelihood of a future issuance, entering into a forward hedge to lock in the market component of that issuance has similarly become attractive. Given the flat-to-inverted curve, the ability to lock in a portion of a bond issuance pricing via a treasury lock or forward-starting swap is historically low, resulting in these instruments being more accessible to companies in this situation.

Debt refinancing

As debt refinancing is never too far off the horizon for most corporate treasuries, the current market also opens new possibilities that may have been untenable during an upward-sloping yield curve environment. Many companies who hedged with swaps in recent years have swaps that have become liabilities as rates have fallen. If your company is in this situation and wishes to extend the tenor of your swaps, a popular strategy has been to "blend and extend." In this trade, the current liability value is blended into a new, longer-tenored swap. The new swap rate will be higher than a market rate but likely is lower than the rate on the existing swap. If you don’t need to blend, you can extend swap coverage by simply layering on a forward-starting swap at market rates.

Additional considerations

Whether your company is looking to hedge floating-rate debt, issuing fixed-rate instruments, or is entrenched in the refinancing process, you may face a host of decisions and considerations that present unique challenges. As the world’s largest and most experienced independent derivatives advisor, Chatham Financial can empower your team to make informed hedging decisions that achieve your objectives.

Chatham Financial Corporate Treasury Advisory

Chatham Financial partners with corporate treasury teams to develop and execute financial risk management strategies that align with your organization’s objectives. Our full range of services includes risk management strategy development, risk quantification, exposure management (interest rate, currency and commodity), outsourced execution, technology solutions, and hedge accounting. We work with treasury teams to develop, evaluate and enhance their risk management programs and to articulate the costs and benefits of strategic decisions.


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About the author

  • Kevin Jones

    Director
    Treasury Advisory

    Corporates | Kennett Square, PA


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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