Nobody knows when the Fed will begin to ease monetary policy, but the first 100bps in rate cuts could pose a risk to both asset and liability-sensitive institutions if deposits costs do not follow market rates lower.
That said, with over 100bps in Fed rate cuts priced in over the next 18 months, it’s no longer possible to hedge these initial rate cuts with conventional structures.
Consider a Flooridor to Protect Against Initial Rate Cuts
A 5% purchased floor + a 4% sold floor (referred to as a floor corridor or "flooridor") provides protection against initial rate cuts.
Breakeven SOFR rate of5.19%in 2024.
Average breakeven SOFR of 4.50% over hedge term.
If rates do not decline, bank expenses ~50bps of premium annually.
For options strategies, we encourage clients to evaluate the breakeven rate by netting any payments received with amortized premium expense. Viewed through this lens, a 5-4% flooridor provides better protection for initial rate cuts than alternatives:
We've provided pricing for various 5-4% flooridors below. Interestingly, there isn't a significant increase in annualized premium expense for longer-dated structures:
Indicative pricing as of 5/22/24
Meanwhile, institutions with pay-fixed swap portfolios continue to evaluate strategies to preserve current gains:
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