- Investors interpreted the June 19 Fed announcement as the coming end of quantitative easing.
- The MMD index went up 60 basis points to 4.13%, the biggest 3-day increase since April 1987.
- A number of hospital refundings were put on hold.
- Rates are unpredictable, but could ease if unemployment levels off or rises.
Last Wednesday, Ben Bernanke announced that the Fed may reduce or “taper” its current purchases of government and mortgage bonds --if the economy meets certain growth targets.
The Fed’s voracious buying (aka Quantitative Easing III or $85 billion/month) has kept interest rates artificially low in order to stimulate the economy.
Pundits say the unemployment rate target mentioned in the Fed’s announcement was lost on investors who proceeded to panic and sell.
We prefer to think the markets took a cold, hard look at unemployment trends and decided tapering may be just around the corner.
The specific target Bernanke said the Fed will look for before tapering is the unemployment rate falling to 6.5% (currently 7.6%), so long as the inflation outlook stays below 2.5% (currently 2.3 to 2.6%).
It’s a fact that unemployment has been on a relatively steady decline since 2010. Looking at the chart, we're not very far from the Fed target rate.
In light of the unemployment trends, it's not hard to see why investors would react as they did last Wednesday.
Impact on Interest Rates
Interest rates soared since Bernanke's heads up. The 30-year MMD, the benchmark index for tax-exempt bond offerings, closed yesterday at 4.13%, up 60 basis points from before the Fed announcement. This is the largest 3-day increase in the index since April 1987.
Credit spreads have also been on the rise, particularly with weaker credits. This can often be the case when supply exceeds demand and investors get away with being more finicky. The net result for the average hospital or health system is a significantly higher cost of funds than just a couple of months ago.
Higher rates were not unexpected. Common sense would dictate that a return from recent record lows to historical averages is inevitable.
Nonetheless, the prognosis was largely ignored by hospitals (see Hospitals Slow to Take Advantage of Low Rates). Analysts only expected a small increase in 2013, which borrowers took as an excuse to sit on refunding opportunities: the Chicago Fed forecasted the 10-year Treasury constant maturity rate to go from 1.7% to 2.0%. Half way through this year, it’s already up to 2.6%.
In hindsight, many borrowers wished they had moved full steam ahead when they could. In the market chaos following the June 19 announcement, most healthcare offerings were pulled and placed on “day-to-day” status, which is Wall Street speak for “we don’t know when we’ll price, but hang in there”.
A bright exception was Cape Cod Healthcare (HFA Partners client), who managed to price a $50 million offering on June 19 only minutes before the Bernanke speech. The contrarian strategy paid off as other deals scheduled after the announcement were put on hold.
Hospitals with refundings out of the money can still find solace in the possibility that rates may ease back.
All that may be needed is for labor market indicators to point to a change in unemployment trends, with the unemployment rate leveling off or climbing. This could lead investors to take a closer look at the Fed target and maybe decide that tapering is further away than thought, and that buying bonds is not such a bad idea after all.
In the short term, nobody knows where interest rates are headed, or if a rally could make up for the recent sell-off. But it can happen.
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