Borrowers often worry about the costs of negative carry, which can easily evolve into a psychological barrier that inhibits the taking of action. However, negative carry, while persistent, remains low due to flatness in the yield curve as compared to previous rate hike cycles.
Perhaps the best place for borrowers to start is to quantify the costs of inaction in monetary terms and to evaluate whether the risks are substantial enough to warrant an intervention.
II. MATCHING SOLUTIONS TO STRATEGIES
Once a borrower’s desired outcomes are defined, a solution that’s best aligned with the firm’s risk appetite can then be selected, from interest rate swaps, to capped interest rate swaps, to interest rate caps, among many others.
As with most solutions, each has its own benefits and pain points. For example, interest rate swaps protect against increases in underlying floating rates, but on the flipside incur initial negative carry when the fixed rate is higher than the prevailing floating rate. Capped interest rate swaps, on the other hand, only protect up to the cap rate and offer lower initial negative carry.
III. SEIZING CURRENCY ARBITRAGE OPPORTUNITIES
While the risks of rising rates are frequently discussed, an overlooked angle is the number of opportunities that such hikes present.
For example, although US rates are going up, rates in many other markets remain stable. That means that borrowers have the opportunity to fund in other currencies such as EUR or JPY at comparatively cheaper rates than they could in USD.
Across the world, most borrowers tend to rely on two primary currencies for their funding needs: their home market currency and USD. This is has become more pronounced since the financial crisis in 2008-2009, especially in Asia where many companies have taken advantage of low USD rates and used dollar funding for their financing needs.