Interest Rates and Market Volatility on the Upswing… Fast

Fed Battles Raging Inflation with Interest Rate Fire Hose; Volatility on the Rise

What the Fed thought in mid-2021 was an isolated inflation dumpster fire has grown into a raging inferno fueled by continuing global supply chain issues, the tragic war in Ukraine and spiking commodity prices.

Responding in its economic smokejumper role, the Fed has dramatically changed its outlook on using interest rate increases as its preferred tool to douse inflation, according to Kiran Kini, CoBank senior vice president and treasurer.

“At the end of last year, the Fed indicated they would raise rates two or maybe three times in 2022,” said Kini. “Now, they’re guiding us to at least seven rate increases this year as a base case, with the first increase—25 basis points—having already occurred on March 16.

“The Fed also is indicating that it will front-load its rate increases, which means there is a high likelihood of back-to-back 50-basis-point increases in May and June (the Federal Open Market Committee, which sets rates, does not meet in April). Again, that appears to be the base case. And the Fed seems to be guiding toward announcing a balance sheet runoff in May, as well. That would remove a significant buyer from the market as they reduce the pace of reinvestments and let their balance sheet begin to run off.”

Kini says the war in Ukraine has caused commodity and food prices to increase, which has further exaggerated inflationary pressures. He added that the uncertainty around a resolution in Ukraine and the ability of rate increases to actually tame inflation are likely to create significant market volatility.

Bye-Bye, LIBOR … Hello, SOFR!

A leader in the horse race to replace LIBOR (London Interbank Offer Rate), the former global standard benchmark interest rate that officially stopped being used on December 31, 2021, seems to be emerging.

The race has been among three odds-on favorites—SOFR (Secured Overnight Financing Rate), which was the rate selected by the Alternative Reference Rates Committee (ARRC) convened by the Federal Reserve Board and the New York Federal Reserve in 2017; AMERIBOR (American Interbank Offered Rate); and BSBY (Bloomberg Short-Term Bank Yield, pronounced bisby)—with the winner likely becoming LIBOR’s replacement as the new U.S. dollar standard.

The primary issue has been that lenders were pushing the rate that best meets their needs in what Clarence Plummer, CoBank senior vice president of capital markets, calls a follow the money scenario.

“The U.S. regulators are pushing for SOFR as the new standard,” said Plummer. “Some large institutions like Bank of America are pushing BSBY. Others—mid-sized regional banking institutions like Zions—are pushing AMERIBOR. It’s all about using the rate that best reflects your cost of funds in good times and bad.

“Now, it appears that some direct pressure from bank regulators is resulting in more banks using SOFR as an alternative to LIBOR than AMERIBOR or BSBY. There are still pockets of the industry that are pushing those other alternative rates, but the momentum has swung toward SOFR. By mid- to late year, I think SOFR will be the dominant benchmark rate.”

Plummer added that SOFR is the benchmark rate that generally benefits many of CoBank’s customers because of the low funding costs. It also is less volatile, or less susceptible to the types of events—such as debt ceiling debates—that tend to raise rates.