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Catalyst: 'Monetary Cocaine' Withdrawal And Rising Rates
PLANO, Texas (9/18/13)--Interest rates have been rising, and the value of credit union bond portfolios has been falling. But people have been talking about the inevitability of higher interest rates for so long that, for many, calling this a trend seems like just another false alarm, said Catalyst Corporate FCU.
"There are those who believe concerns over increasing interest rates are overblown, that the economy is not strong enough to sustain increases, and that long-term rates are bound to fall again," said Tim McWilliams, Catalyst senior investment officer and a registered representative for CU Investment Solutions LLC, in Catalyst's press release.
"Whether interest rates rise now, in six months or in a year, if a credit union has bought long-term fixed-rate bonds, it is vulnerable to a potential continued rise in interest rates," he said.
Richard Fisher, president of the Dallas Federal Reserve, described the current monetary environment as a market is on "monetary cocaine." The reference alludes to the Federal Reserve's $1 trillion-plus stimulus to the economy through monthly large-scale asset purchases in its quantitative easing program. When asked about the impact of rising bond yields on the economy, Fisher responded that policymakers could not let the markets dictate monetary policy.
"The Federal Reserve has been buying $85 billion a month in longer duration treasuries and mortgage-backed securities," said McWilliams. "These purchases have kept long-term interest rates at historically low levels, helping to revitalize the housing market and other sectors that rely on housing."
With the Fed saying it is 'broadly comfortable' with beginning to taper these purchases, many economists believe the Fed will decide to reduce the pace of the bond purchases as early as this month.  Its Federal Open Market Committee has been meeting Tuesday and today to determine the next step. (News Now will provide an update this afternoon on FOMC's statement after the meeting.)
"The mere hint of the Fed removing that stimulus has caused the rate on 10-year treasuries to rise from 1.62% on May 2 to the current yield of 2.9%," McWilliams said. "Whether the Fed begins to taper in September is anyone's guess. The Fed has made it clear it wants to end quantitative easing; it's just a matter of how much [the committee] will taper and how quickly."
Credit unions are prudent to consider whether the market has become "addicted" to low long-term interest rates, he said, adding, "If so, how bad will the withdrawal symptoms get? And without the Fed buying bonds, where will a free market reset long-term interest rates?" he asked.
Analyzing rising rate scenarios in a credit union's asset liability management model is the first step in positioning its balance sheet to respond to these withdrawal symptoms, said McWilliams. The second step is analyzing the credit union's investment portfolio to determine if portfolio strategy or individual holdings are putting the credit union at risk.
"Does your credit union have a properly diversified portfolio? Does it have a mixture of both long-term and short-term bonds? Does utilizing a larger portion of adjustable-rate securities to hedge your fixed-rate holdings make sense?"

McWilliams asked. "These are questions that credit union senior management needs to be asking now. It's time to reevaluate your balance sheet and investment portfolio and determine the potential implications."

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