beta, decay and how to prepare for a rising rate environment september 2013

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Beta, decay and how to prepare for a rising rate environment

September 2013

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The level of interest rates drives beta and decay . . .

• Higher rates typically drive higher betas and higher levels of decay• Beta and decay levels are impacted by:

• the level of rates• the slope of the curve, and• how competition responds.

• Beta and decay levels are forward looking and need to be fluid to changing market conditions.

Long rates have been volatile since early spring due to events like Cyprus and the Fed slowing down operation Twist . . .

4/11/2013: Cyprus temporarily flipped the risk-on / risk-off switch to “off” causing a near-term flight to safety and a rise in Treasury and German Bund prices:

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0.8% 0.8%1.5% 1.9% 1.9% 2.1% 2.1% 2.2%

3.3% 3.3% 3.4%4.3% 4.6%

6.2%

9.9%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0% 6/19/2013: Given United States’

fiscal situation it cannot be long before markets swing against the World’s Reserve Currency

The impact to the US interest rate environment for the short term is contingent upon Fed action. Longer term, the Debt / GDP issues will persist . . .

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Longer-Term Shock Situations

Through 2013

Third Quarter 2013

Anticipation of Fed Withdrawal and Change

in Purchasing

Yield Curve Steepens

No Recovery

Fed Tapers

Steady Rate Rise

China or Japan Pull-Back Purchases:

Rates Rise

Economic Uncertainty

Leads to further stimulus

Flat / Depressed

Debt / GDP

Grows to 120%:

Rates Rise

Economic Recovery

Fed Tapers

Flat / Inverted

Government Cuts Spending:

Rates low for 18 mo. then rise as economy

improves

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Which is likely? Since actions are based on the economy, it is important to note that the Fed projects unemployment to improve and inflation to remain tempered . . .

Source: Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents June 2013

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