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Assessing the Impact of the Fed’s Interest Rate End Game

Step-by-step scenario planning enables treasury to prepare corporate credit facilities for future movement in rates.

By Peter Seward | December 06, 2018 at 01:32 PM

Ten years after the credit crisis, and with the Federal Reserve raising rates eight times since 2015, the end game is fast approaching. As the U.S. economy has strengthened, the effect of rate increases on the yield curve has been uneven, resulting in speculation about prospects for a yield-curve inversion. Macroeconomic factors like trade policy, emerging-markets volatility, and quantitative easing in Europe further complicate the landscape.

Everyone seems to have a view about the future, although which view is prevailing changes regularly. One thing is clear, however: Further rate increases are very likely. We don’t know how many, for how long, or what their effect on the yield curve may be. However, corporate treasury and finance professionals can use scenario analysis and simulations to assess the impact of the Fed’s interest rate end game.

End of the “New Normal”

Figure 1 compares historical three-month LIBOR (London Inter-bank Offered Rate) levels with the effective federal funds rate. It shows that—historically and, especially, more recently—LIBOR rates track with movements in the federal funds rate. Therefore, Federal Reserve policy and future fed funds rates are useful guides to future LIBOR rates.

Consider the case of a typical U.S. corporate that entered into a revolving floating-rate line of credit (three-month LIBOR, plus 150 basis point credit spread) a few years ago and is due to renew the credit line in a year.

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