Rates Will Continue to Rise Through End of ’22, Possibly Longer; Fed Risks Recession, Higher Unemployment

October 6, 2022

The Takeaway provides practical commentary on interest rates, derivatives and capital markets activities. These insights come from the professionals in CoBank’s Treasury and Capital Markets groups—people who are in the market interacting with customers, investors and other lenders seeking to understand what is driving activity.

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Could the Third Time Be the Charm? Unlikely … and the Fourth Time May Not Be Charming Either

If today’s price inflation had a portrait, it might appear next to the definition of stubborn in the dictionary.

Inflation has come down only slightly from its recent 40-year high, prompting the Fed to raise the federal funds rate by 75 basis points (.75%) a third consecutive time to a target range of 3–3.25% at its late-September meeting. The increase follows increases of 75 basis points at the Fed’s June and July meetings (there was no August meeting).

Additionally, Fed Chairman Jerome Powell held out the likelihood of additional rate increases at the Fed’s remaining 2022 meetings in early November and mid-December (there is no October meeting).

Powell suggested that the Fed will raise the fed funds rate by another 125 basis points—to a level between 4% and 4.5%—by the end of the year. Such a move creates the possibility of yet another 75-basis-point increase followed by a 50-basis-point increase or, depending on what data show over the next month, two consecutive 50-basis-point increases for a slightly smaller increase of 100 basis points.

“Chairman Powell acknowledged that the Fed’s rate increases are going to be painful for households, but they’re going to do whatever they can to get inflation under control,” said Kiran Kini, CoBank senior vice president and treasurer. “They are committing to higher rates even at the expense of higher unemployment and a recession, because they view that as the right thing to do in the long run.

“Our base case view remains that there will be a recession in 2023. It’s hard for the Fed to get inflation under control without reducing demand because the supply-side issues are taking longer to fix than anticipated. The only tool they can use to get inflation under control is to reduce demand, which has painful consequences.”

Amid the Fed’s tightening, a strong U.S. dollar also is playing a role. Typically, the strengthening of the dollar against foreign currencies would suppress global demand. However, demand for many American agricultural goods remains strong because of the shortage caused by the catastrophic war in Ukraine. 

What’s coming next in the ongoing interest rate saga? Tune into the news on October 13, 2022, when the Bureau of Labor Statistics will release the Consumer Price Index (CPI) for September. The CPI—which was 8.3% in August—is one of the primary gauges of annual inflation.

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Go Figure: Predicting the Future Is Harder Than It Seems

Customer hedging activity driven by the volatile interest rate environment continues to be extremely active, but market volatility is blurring the picture. “Customers are trying to establish some certainty with their debt service, but achieving that has been made more difficult by trying to read the forward curve, which historically has told us what the market thinks the Fed is going to do,” said Eric Nickerson, CoBank’s sector vice president of customer derivatives.

“The forward curve has been inverted, which would indicate that longer-term rates would be higher than short-term rates. But the forward curve has been very deceptive throughout this tightening cycle. The expectations of the forward curve a month ago, three months ago or six months ago simply haven’t played out.

“From a transaction structuring standpoint, we are seeing some customers gravitate to shorter-term transactions for fear of having to lock in at a higher future rate if the forward curve does actually play out the way it’s priced,” Nickerson continued.

“That’s what we’re all grappling with—where do we go from here? The Fed says that its decisions will be data dependent. If we don’t see inflation easing, the Fed has made it clear that they will continue raising interest rates.”

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Syndicated Loan and CLO Trading Goes Digital

Seven U.S. megabanks and a leading financial data and analytics provider have joined forces to create an automated platform for trading syndicated loans to collateralized loan obligation (CLO) funds. There are plans to use the platform, in time, to trade other structured assets. The platform—which is operated by a newly formed, independent company called Octaura Holdings—will automate what has traditionally been a highly manual process since syndicated loans began trading some 30 years ago.

The initiative that created Octaura was led by Citi and Bank of America, which were joined by Credit Suisse, Goldman Sachs, J.P. Morgan, Morgan Stanley, Wells Fargo and Moody’s Analytics.

“What we’re seeing is the creation of a very innovative platform that will bring to capital markets a fully digital approach for trading, settling and administering syndicated loans among financial institutions and potentially other investors,” said Clarence Plummer, senior vice president, Capital Markets for CoBank. “It will take a lot of the inefficiencies and time out of the current system and really ease the process of buying and selling leveraged loans.

“The creation of Octaura speaks to the size of the leveraged loan market, which is now valued at more than $1 trillion,” Plummer continued. “As CoBank and the Farm Credit System continue to use technology to enhance our customer experience, we may be able to utilize some of the innovation that other non–Farm Credit System institutions are employing in our dealings with our customers.”

The CLO and syndicated loan markets have doubled in size over the last decade to more than $1 trillion and $1.4 trillion in outstandings, respectively.

Background: CLOs are individual securities backed by a pool of debt, which is typically composed of low-rated corporate loans or loans taken out by private equity funds for leveraged buyouts.

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