The Macroeconomic Outlook and Ability Management Strategies

What the paper says

The current macroeconomic outlook presents a duality: On the one hand, Federal Reserve forecasters believe that shortterm rates will remain excessively low (0-25 basis points) for a prolonged time period, possibly extending into 2015. On the other hand, the balance sheet of the Federal Reserve has nearly tripled ($850 billion versus approximately $3 trillion) since the onset of the great contraction of 2007 – 2009, possibly suggesting skyrocketing future inflation accompanied by skyrocketing interest rates. This duality intuitively suggests that an optimal funding strategy might consist of short-term borrowings (to exploit the low short-term rates) coupled with long-term borrowings (to hedge against rising inflation and interest rates). In this paper, I empirically demonstrate that a barbell funding strategy is indeed on the efficient frontier, and most efficient frontier strategies consist of the barbell with episodic inclusions of the 5-year, particularly under increased liquidity or funding risk eventualities. Once we delineate the efficient frontier, the Chief Financial Officer (CFO) can choose the optimal fixed versus floating mix based on his pain tolerance for declines in earnings per share (EPS) given likely moves in short term rates.