fifth third financial risk solutions interest rate
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© Fifth Third Bank | All Rights Reserved Confidential – For Discussion & General Information Purposes Only
Fifth Third Financial Risk Solutions
Interest Rate Management in a Fed Tightening Cycle April 2018
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Introduction
Swap transactions may not be suitable for all entities or persons, involve the risk of loss and should only be undertaken by those who are Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only and is subject to change.
Darren Kirby
Managing Director
Interest Rate Management
Tel. 312.704.6941 222 S. Riverside Plaza
Cell 312.798.9844 30th Floor GRVR0C
[email protected] Chicago, IL 60606
Darren Kirby joined Fifth Third Bank’s Interest Rate Management group in 2006, and in recent years has helped to develop Fifth Third’s corporate interest rate hedging business. Darren has worked in interest rate derivative sales, providing hedging strategies for clients, for the last 18 years. Prior to specializing in interest rate hedging solutions, Darren held various roles in capital markets and risk management, including work with the consulting arm of a Big Four firm in New York, focusing on risk management for international financial institutions. Darren holds an MBA from the Stern School of Business at New York University and a Bachelor of Science in Economics from the Wharton School of Business at the University of Pennsylvania.
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Interest Rate Environment Overview
Fifth Third Bank is pleased to have the opportunity to provide a review of the current interest rate market and simple
hedging strategies to deal with rising interest rates.
Most borrowers enjoyed a protracted period of low interest rates engineered by the Federal Reserve to help accelerate
growth, inflation and employment in the United States.
Beginning in 2007, the Fed sought to provide monetary accommodation to the US economy in the beginnings of the deepest
recession experienced since the Great Depression. From September 2007 to early 2009, the Fed continued to drop its target
Fed Funds rate from 5.25% to an ultimate low of 0.00 – 0.25%, where it stayed until December 2015.
Finally in December 2015, the Fed began to raise its target Fed Funds rate again and has since hiked rates on the short end
of the curve now six times (1x in 2015, 1x in 2016, 3x in 2017, and 1x already in 2018), bringing its target Fed Funds rate up
to 1.50 – 1.75%.
Furthermore, the Fed’s quarterly Summary of Economic Projections released in March now indicates a median forecast for
further hikes (2x in 2018, 3x in 2019, and 2x in 2020) adding up to seven more rate hikes by the end of 2020. This path
would raise the Fed Funds target rate to a range of 3.25 – 3.50% by the end of 2020.
While inflation has been relatively subdued since the Fed began its rate hikes at the end of 2015, recent indicators show
firming in prices, with Core CPI in the last quarter increasing at a 2.9% annual rate and with Producer Prices up 3.0% year
over year.
Market pricing appears to continue to price in a lower trajectory for rates, with two additional rate hikes largely priced into
Fed Funds Futures for 2018, but only about 1.7 hikes priced (in comparison to the Fed median forecast of three) in 2019, and
about 0.3 hikes (in comparison to two) in 2020.
Swap transactions may not be suitable for all entities or persons, involve the risk of loss and should only be undertaken by those who are Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only and is subject to change.
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Interest Rate Environment
Historical Target Fed Funds Rate (Upper Bound) and One Month LIBOR
Prior FOMC Rate Hike Cycles - How Much and How Fast?
Swap transactions may not be suitable for all entities or persons, involve the risk of loss and should only be undertaken by those who are Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only and is subject to change.
Decrease of 475 bps in 12 Months
Increase of 425 bps in 24 Months Decrease of
500 bps in 15 Months
Increase of 175 bps in 10 Months
Increase of 300 bps in 12 Months
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Central Bank Policy
April Economist Survey – June Fed Funds Target (Upper Bound)
Forward Rate Comparison
Swap transactions may not be suitable for all entities or persons, involve the risk of loss and should only be undertaken by those who are Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only and is subject to change.
Year End 2018
Year End 2019
Year End 2020
Dec 13, 2017 FOMC Median Projected Fed Funds Rate
2.125% 2.6875% 3.0625%
March 21, 2018 FOMC Median Projected Fed Funds Rate
2.125% 2.875% 3.375%
April 20, 2018 Fed Funds Futures 2.165% 2.580% 2.650%
April 20, 2018 1mLIBOR Forwards 2.402% 2.768% 2.881%
April 20, 2018 3mLIBOR Forwards 2.635% 2.923% 3.012%
Source: Bloomberg as of April 20, 2018 and FOMC Summary of Economic Projections as of December 13, 2017 and March 21, 2018 Bloomberg Economist Survey as of April 12, 2018
FOMC Participant Fed Funds Projections & Market Futures
The Federal Reserve followed through with a much anticipated 25 bp rate increase at its scheduled meeting on March 21, raising the Fed Funds rate range to 1.50%-1.75% with a unanimous vote, and forecast a steeper path of rate hikes in 2019 and 2020, citing a stronger economic outlook and greater confidence for higher inflation with an economy that is receiving a boost from tax cuts and government spending at a time when unemployment is low and growth above pace.
While Fed officials maintained their median projected rate increases for 2018 to three 25 bp rate hikes, note that a change from 3 to 4 hikes in one projection would have changed the median for 2018 to 4 hikes.
The Fed Funds Futures market, however, continues to discount potential Fed tightening activity. Fed Funds Futures currently imply a 92% probability of a 25 bp rate hike in June and only 89 bps of additional rate increases by the end of 2019 (compared with the most recent median Fed rate projections of 125 bps of additional rate increases by the end of 2019).
In a recent interview the Federal Reserve Bank of Dallas President Robert Kaplan continued to make the case for two additional rate hikes this year. He further said, “I think the path of rate increases is probably going to be flatter than people are accustomed to and one of the reasons is this moderating out-year growth”.
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
2018 2019 2020 Longer Run
Dec 2017 Median Mar 2018 Median Current Market Futures
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Interest Rate Environment
Historical Treasury Yields
Treasury Yield Curve Changes Historical Libor and Averages
Swap transactions may not be suitable for all entities or persons, involve the risk of loss and should only be undertaken by those who are Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only and is subject to change.
Source: Bloomberg as of April 20, 2018
Payroll gains slowed to 103,000 in March following a slightly upwardly revised gain of 326,000 in February. While the March payroll data was well below the consensus expectation of a 185,000, payroll gains have now average 202,000, 211,000, and 188,000 over the last three, six, and twelve months, respectively, supporting the basic view that the underlying pace of job growth remains healthy.
The unemployment rate remained at 4.1% for the 6th month, the lowest level since 2000, while average hourly earnings, a bright spot in the report, showed a 0.3% month over month gain and a 2.7% year over year gain, matching expectations and exceeding prior month levels of 0.1% and 2.6%, respectively.
While labor market progress may be returning to a more sustainable pace, it likely keeps Federal Reserve policy makers on track for further interest rate increases.
Higher and broader tariffs from a trade war could raise prices of certain imports, potentially fanning U.S. inflation while reducing economic activity by sapping confidence and tightening financial conditions. Share prices would likely decline further in a full blown trade war and lower wealth could lead to slower growth in U.S. consumer spending.
After reaching 2.95% in late February, the 10 year Treasury yield dropped again to 2.73%. however, as recent trade war, geopolitical and equity market concerns have faded somewhat, it reached a new cycle high of 2.96% late last week.
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Interest Rate Environment
Steepness: 5 Year Benchmark LIBOR Swap Less 1M LIBOR LIBOR Swap Curve Changes
5 Year Benchmark LIBOR Swap One Month and Three Month LIBOR
Swap transactions may not be suitable for all entities or persons, involve the risk of loss and should only be undertaken by those who are Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only and is subject to change.
Source: Bloomberg as of April 20, 2018
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Historical LIBOR Swaps – Post-2016 Election
Swap transactions may not be suitable for all entities or persons, involve the risk of loss and should only be undertaken by those who are Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only and is subject to change.
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Labor Market
Swap transactions may not be suitable for all entities or persons, involve the risk of loss and should only be undertaken by those who are Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only and is subject to change.
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US Treasury - Leverage
Swap transactions may not be suitable for all entities or persons, involve the risk of loss and should only be undertaken by those who are Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only and is subject to change.
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Market-Based Forward Rate Expectations (1-month LIBOR)
Swap transactions may not be suitable for all entities or persons, involve the risk of loss and should only be undertaken by those who are Eligible Contract Participants as defined in Section 1(a)18 of the Commodity Exchange Act. There is no assurance that any transaction will achieve its anticipated objective. Past performance is not indicative of future results. Any pricing herein represents an indicative quote only and is subject to change.
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About Fifth Third Capital Markets
Fifth Third Capital Markets is the marketing name under which Fifth Third Bank (“Fifth Third”) and Fifth Third Financial Risk Solutions (“FTFRS”), a division of Fifth Third, provide financial risk management products and services, including derivatives products. Fifth Third Bank is a provisionally registered Swap Dealer with the Commodity Futures Trading Commission (“the CFTC”). Important Notice FTFRS is subject to Commodity Futures Trading Commission (“CFTC”) rules which require FTFRS to communicate with clients in a fair and balanced manner based on principles of fair dealings and good faith. The specific risks presented by a particular Swap necessarily depend upon the terms of the Swap and your present and future circumstances. In general, however, all Swaps involve one or more of the following risks - credit risk, market risk, liquidity risk, funding risk, operational risk, legal and documentation risk, regulatory risk and/or tax risk. To provide FTFRS clients with a sound basis for evaluating the facts with respect to the Swaps discussed herein, prior to execution clients are encouraged to review material information disclosed to them during the: - Onboarding Process: ISDA Protocols, Master Agreement & Credit Support Documentation, or the FTFRS Bilateral Dodd Frank Agreement - Pre-Trade Negotiations: Contact FTFRS or visit https://www.53.com/resource-center/swap-dealer-disclosures.html If after review of this presentation and the disclosures referenced herein, you have any questions pertaining to the discussed transaction, please contact FTFRS. This document has been prepared by Fifth Third Bank (“Fifth Third”) or one of its subsidiaries for the sole purpose of providing a proposal to the parties to whom it is addressed in order that they may evaluate the capabilities of Fifth Third to supply the proposed services. It is not intended to provide specific investment advice or investment recommendations and does not constitute either a commitment to enter into a specific transaction or an offer or solicitation, with respect to the purchase or sale of any security. The information contained in this document has been compiled by Fifth Third and includes material which may have been obtained from information provided by various sources and discussions with management but has not been verified or audited. This document also contains confidential material proprietary to Fifth Third. Except in the general context of evaluating our capabilities, no reliance may be placed for any purposes whatsoever on the contents of this document or on its completeness. No representation or warranty, express or implied, is given and no responsibility or liability is or will be accepted by or on behalf of Fifth Third or by any of its subsidiaries, members, employees, agents or any other person as to the accuracy, completeness or correctness of the information contained in this document or any other oral information made available and any such liability is expressly disclaimed. This document and its contents are confidential and may not be reproduced, redistributed or passed on, directly or indirectly, to any other person in whole or in part without our prior written consent. This document is not an offer and is not intended to be contractually binding. Should this proposal be acceptable to you, and following the conclusion of our internal acceptance procedures, we would be pleased to discuss terms and conditions with you prior to our appointment.