Real interest rates (nominal interest rates – inflation) have reverted to an increasing trend line over the last three months after nearly going back to zero in December and January.
As illustrated in the graph below, over the last 36 months real interest rates for the 5 year swap have been mostly negative with a narrowing trend line ultimately converging to a positive real interest rate in August 2013.
CGCF market analysts expect real interest rates for the 5 year swap to stabilize or rise slightly through August 2014. A more dramatic rise in real interest rates will be dampened as a result of perceived waning in the Fed’s hawkish motivations related to reduced near-term economic activity during the harsh weather in Q4 2013 and Q1 2014.
However, we believe that after this stabilization period over the next 4-5 months, real interest rates are going to rise in a much more aggressive fashion and will continue a strong upward trend line well into 2016. Further, as we approach 2016 and the reality of a new, business friendly U.S. administration becomes more apparent, market perception of an impending positive business environment will increasingly create upward pressure on real interest rates.
If economic data improves more rapidly than expected, the 4-5 month stabilization period will be much shorter or non-existent leading to an aggressive rise in real interest rates much sooner.
Long term look-back data is clear that we are on a long term trend line of increasing real interest rates. Short term equity market volatility and resultant temporarily lower Treasury rates over the near term should not distract from this upward trend.
As we have previously urged many of our readers since July 2013 (real interest rates for the 5 year swap have gone up 326 bps since our call in July 2013!), prudent corporate Finance decision makers should seriously consider:
1. Identify all debt tranches contained within variable rate facilities used to procure long-term capital assets.
2. Identify all capital assets unencumbered with direct debt/lease liabilities.
3. Recast all or a large portion of such debt tranches and unencumbered capital assets on a fixed rate, long term (matching the capital asset’s useful or contract production life) lease or debt instrument.
4. Establish a Lease or Fixed Debt facility for your projected 2014 and 2015 CapEx procurements.
Accomplishing some or all of the above considerations could provide your organization with clear competitive advantages including:
- lower weighted cost of capital
- greater business operations flexibility
- higher cash balances
Benefits associated with these advantages are many and include the use of cash as dry powder for acquisitions, greater liquidity in the face of economic downturns as well as growth opportunities including new product development and/or extension of service lines to meet your customer’s needs.
