In some ways, the turning of the calendar to a new year does what no other deadline nor holiday can do – generally speaking, it stops you in your tracks. Your time and team ran out as if you just played the biggest bowl game of your life, and having secured the victory in the 4th quarter, commenced celebrating the season in grand fashion. Congratulations all around to your winning team! What followed was a well-deserved break, and time to reconnect with friends and family. Wrapping up and reflecting on the prior year, you can be proud of what you accomplished, but still resolve to come back stronger and better prepared next year.
Welcome to next year. 2014, that is. Unlike in football, there is no offseason in your business. There is, however, a rhythm and routine that you will tap back into – some of us faster than others. The good news is that new developments in the derivatives and hedging world don’t usually come when no one is around to contemplate and appreciate them! Most of what will impact your hedging program in 2014 is already known, having come out in pronouncements, press releases, and notices of proposed rulemakings in the prior year. But just because you know what’s coming, that doesn’t mean you know how this year’s hedging season will unfold. Therefore, it’s worth examining more closely those areas of Fed policy (Part I), derivatives regulation (Part II), and hedge accounting (Part III) that will impact your program, to understand your management of business risks in 2014.
Part I: Fed Policy The biggest news no doubt is the departure of Ben Bernanke, with Janet Yellen going through Senate Confirmation for the seat today. After nearly 8 years at the helm, Ben Bernanke departs his post January 31st, leaving behind a Fed balance sheet that exceeds 4 trillion dollars, having ballooned so large under the policies of quantitative easing. To date, this has generally accomplished what was intended – namely, placing downward pressure on longer-term interest rates, which has powered a steady supply of business and residential refinancing for those in a position to do so. At the last FOMC meeting of 2013, a reduction in asset purchases from $85 bn to $75 bn per month was announced, the beginning of the long-awaited taper. But make no mistake, the Fed balance sheet continues to expand. There is consensus, even within the FOMC, that the balance sheet cannot expand indefinitely, and that taper must eventually lead to cessation of asset purchases, and a significant amount of de-levering. But when? At what rate? And, by how much? These are the questions left to Janet Yellen and the committee to resolve, and the ones that could begin to impact your hedging decisions in 2014.
Market participants largely expect Yellen to follow Bernanke’s lead, and emphasize the need for certain positive economic data, especially in the employment numbers, before committing to further tapering or changes to the balance sheet. What continues to give the Fed room to maneuver is ultra-low inflation, allowing the Fed to focus intently on maximizing employment. But there is also concern that the Fed has little ability to pivot if inflation were to rear up in 2014, or if exceedingly low inflation were to become a problem of its own. When the game plan calls for removing accommodation slowly and methodically, how do you do so quickly and just-in-time, without major market disruptions or throwing the economy into recession? Perhaps we have another year of QE taper and near zero fed funds target rates ahead. It’s also possible that to take the fight to inflation tomorrow, the Fed would have to act today, anticipating considerable lag. As much as people think “status quo” when the new Chairwoman takes her seat at the head of the table, Janet Yellen would undoubtedly open up a second front against inflation if the need arose, which is why the Fed’s reaction to incoming economic data continues to be what to watch in 2014.
As with any game, a break in the action lets you catch your breath and get refreshed for future action. Whether you plan to ease on into 2014, or take the year by storm, don’t hesitate to lean on Chatham to help you assess the impact on your business and hedging programs from Fed policy, derivatives regulation, and changes in hedge accounting rules. Welcome back!
Don’t forget to tune in next week for part two in this three part series on the hedging outlook for 2014, Part II: Derivatives Regulation
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