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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.
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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
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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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