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Incorporating Expectations into Hedging Decisions

How risk managers should respond to changing yield curves.

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The problem with expectations is that you can’t count on them.

Although the financial landscape is ever-evolving, this year’s inversion of the yield curve on Treasuries marked a significant shift in expectations. Under a normal yield curve, where longer-maturity interest rates are higher than shorter-maturity rates, consensus expectations generally call for rising short-term interest rates. But the recent inversion flipped those expectations. For as long as the inverted yield curve persists, the consensus forecast will point to falling short-term interest rates. This change has a critical impact on the economics of hedging.

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