he history of interest rate movements from 1960 through 1981 was dominated T by two features. First, rates trended sharply higher. The prime rate rose from 10% in 1977 to average 19% in 1981. Over this same period, Treasury-bill rates rose from 6 to 14% and Treasury-bond yields rose from 7 to 14%. Second, volatility in rate movements has virtually exploded. Since the Federal Reserve stopped pegging the Federal funds rate h Oetober 1979, average monthly moves in bill yields have increased fivefold--from 50 to 250 basis points.
All financial institutions have been jolted by this volatility. Institutions which relied on the time-tested ''borrow short and lend long" have been squeezed by the upward trend in rates and by frequent inversion of the yield curve. Savings and loan associations, in particular, have been caught between accelerating deregulation of deposit accounts, rising short-term interest rates, and a balance sheet heavily weighted down by low-rate long-term mortgages.
The long-term objective of many thrift managers is to a c b e a more closely matched balance sheet structure in order to reduce exposure to itlterest rate swings. A strategy for doing that while ensuring that the matched balance sheet generates a positive spread is to emphasize "marginal matching" whereby equal asset and liability rate sensitivities are tailored on the marginal cash flow. Over time, this marginal matching wodd generate a profitable and balanced portfolio. Unfortunately, the pace of this transition is glacial. Given the recent poor performance of savings flows, it could take a very long time before the entire portfolio rolled over. A quicker "fix" is to aggressively issue long-term liabilities and use the proceeds to purchase short-term assets. This would indeed narrow the balance sheet gap but only at the risk of locking in a negative spread.
In this light it is vitally important for S&Ls to utilize d the tools at their disposal in effecting a profitable transition. One important tool is the recently granted authority to take short positions in financial futures markets. As a tool for protecting against further rate increases, when they are forecast to occur, futures are hard to beat.
Unfortunately, this futures strategy for protecting against rising interest rates seems to require an accurate interest rate forecast if it is to work. Yet it is precisely Jeflrey K. Speakes is Vice President, U.S. Financial Services at Claremont Economics Institute. He hdds a PkD. from the University %f Calfornio, Berkeley, a d w formerly on the faulty of Ckrrernont Graduate School.
The J o d of Futures Mukey V d 2, No. 3,185-190 (1W) 0 1983 by John Wdey EL Sons, Inc ccc oz1o131ys3Ea#)181.60