Don't Fade the Fed: Strategies for the Next Rate Cycle
August 7th, 2025
After nearly a nine-month hiatus, the FOMC will likely resume rate cuts at its September 17th meeting (95% likelihood according to futures markets). We've observed two key changes to client hedging flows. First, institutions with earnings risk in a lower rate environment are accelerating receive-fixed swap executions. Second, banks with rising rate exposure are using collars instead of swaps to provide a better buffer should rates decline.
Hedging Against Declining Rates
Laddered Receive-Fixed Swaps:
Instead of executing a 3y receive-fixed swap at 3.31%, consider combining:
Spot-starting 1y swap at 3.76%
1y forward-starting 2y swap at 3.09%.
The combination creates 3-year protection with a 45 bp higher rate in year 1 versus a conventional 3-year swap.
The illustrations below compare the impact of a $50mm laddered swap strategy with that of a conventional receive-fixed swap (using a sample risk profile of a $1.5B institution):
Year 1 NII Profile: Laddered Receive-Fixed (1y+ 1y2y)
*Indicative as of August 7th
Year 1 NII Impact: Conventional Receive-Fixed (3y)
*Indicative as of August 7th
Hedging Against Rising Rates
In our recent webinar, we highlighted the shift to options-based strategies. Activity over the past few weeks has reinforced this trend, with particularly strong demand for collars, which we first described in this strategy piece.
Purchased Cap Collars:
Depositories continue to capitalize on option market dynamics where costless collars can be executed with caps struck closer to at-the-money (ATM) rates than the corresponding sold floor. Our clients have executed several billion in collar notional, gravitating towards purchased cap strikes around 4.50%. Pricing has improved substantially since last Friday's jobs report:
*Pricing is indicative as of August 7th
Please reach out with any questions or for pricing on specific structures.
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Past performance is not indicative of future results. Institutions should consider whether derivative transactions are appropriate in light of their own financial objectives, experience, operational resources, legal capacity and regulatory authority. This communication is intended as an information resource only. It does not contain financial, tax, accounting or legal advice and should not be considered an explanation of all relevant issues or considerations in connection with applicable law, or tax and accounting rules and regulations.
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