Oooh and Ahhh, fireworks

Did your town scale back its fireworks display this year, or cancel it altogether? It’s still very hard to justify such expenditures in many parts of the country, even as the economy continues to improve. If you took Friday off to make a solid family four-day weekend, you’re probably just now hearing about the fireworks your coworkers witnessed when the employment report was published Friday morning. Those (un)lucky few who held down the fort saw a spectacular display that started with nonfarm payrolls popping 195 thousand jobs, 20 thousand more than expected. They subsequently watched as interest rates shot up into the stratosphere, in colorful bursts of higher 5, 7, 10, and 30 yr treasury yields, which rained down elevated interest rates on businesses large and small. What a sight to see! But as with any fireworks display, while some folks can “ooh” and “aah” and thoroughly enjoy the show, others had to cover their ears and close their eyes, the rate show being too much and too fast for their liking.

Not everyone can enjoy interest rate Independence Day because many are still beholden to what the market has yet to deliver. If you have already fixed your debt service, then days like Friday turn out to be rather enjoyable, with less focus on the Fed and interest rates, and more attention available for other business needs (like customers!). Rate watching has never been a sport for the faint of heart, but a 20 basis point run up in long term rates does have a tendency to focus the mind like nothing else. Sure, rates may be up more than 1 percent over this time two months ago, but that doesn’t mean that you don’t still have choices. In fact, there are three paths from here to interest rate independence, but know this: they are not all the same, nor will they necessarily produce the same outcomes. Still, knowing your choices is always the first step. Which one is right for you?

Choice #1 – Be like Ben. Chairman Bernanke needs to determine when to withdraw stimulus by paring his bond buying program. You need to determine when he will do this, so you can stay a step ahead. As he does so, the pressure exerted by the Fed on longer term rates will diminish, and they will be more greatly influenced by market expectations and the demand for greater yield for taking longer risks. So, when do you taper? To know this, you will need to monitor what the Fed monitors, and dig deeply into employment data and the outlook for inflation, as well as the greater economy. For example, the nonfarm payrolls number was hugely positive, but is a 195k monthly trend enough to absorb all the newly minted college and high school graduates? What about discouraged workers, and those underemployed relative to education, or those who have left the workforce – how does the strengthening economy affect them, and impact the timing to get within the Fed’s target to withdraw accommodation? Most of the run up in rates thus far is from market participants trying to anticipate the Fed’s moves, and to be like Ben you will need to join them. If the fundamentals are not strong, then maybe the Fed does not move for a while after all, and longer term rates come back down. Either way, it’s a guessing game for everyone but Chairman Bernanke, which is why this approach has more in common with speculation than hedging. Do you really want to take up the dismal science, and engage in this kind of guesswork, just to know when you should swap your loan to fixed?

Choice #2 – The View. Joining the cast of The View means having an opinion and putting it out in public for all to see and hear. Some audience members will nod approvingly in consent when you explain your position, while others will strongly disagree with your opinions and let you know just how wrong you are! Having a view means you will be compelled to revisit it often, and also justify and defend it – to coworkers, committee members, and the boss. But members of The View can enjoy floating at lower short term rates for now precisely because they have an opinion on longer term rates. Importantly, though, they have set one or more triggers to enter the market before rates run away from them, which means there is a good chance they have already taken such steps to hedge or will now after Friday’s rate run-up. Clearly, you need to be thick-skinned to have a view, but to be successful you also need to be disciplined and dispassionate and move when action is called for. Is this the best path for you, to join The View?.

Choice #3 – The Introspection Hedge Election. With choice number three, you are aware of current market conditions, but from there you look inward. Know yourself, and your business. What is your exposure to rising rates? What is your tolerance for interest rate risk? What events in your business plan are impacted by this uncertainty? A dose of reality settles in. “Short term rates are low right now, but I have (5, 7, 10) year floating rate debt to look after! I need some assurance that ‘X’ years from today my debt service will be known, tolerable, and not impairing my business or occupying my time.” Do you think you will know when we hit the bottom? Is it possible we already did? Can you beat the Chairman at monetary policy, or anticipate the moves of those who try? You may be quite good at these games, but your attention to interest rates could mean inattention elsewhere. Choosing to hedge based on introspection is truly based on what you know – yourself and your business. No one knows it better than you.

If you need help choosing from among your choices, give us a call!