Easing Inflation and Cooling Labor Market Cement Path to Fed Rate Cuts
At its last meeting on July 31, 2024, the Federal Open Market Committee (FOMC) decided to keep interest rates unchanged at 5.25% to 5.50% as widely expected. However, the Fed's statement indicated a shift from a previous stance of tightening to a more neutral one, hinting that a rate cut could be on the table for their next meeting on September 18. In fact, in his recent Jackson Hole speech, FOMC’s Chair Powell expressed more confidence in the inflation outlook and put more emphasis on downside risks in the labor market, where he said that any further weakening would be “unwelcome.”

Furthermore, Mark Zandi, Chief Economist at Moody's Analytics, recently spoke at the  Federal Home Loan Bank of San Francisco (FHLBank San Francisco) 2024 Member Conference, where he predicted that the Fed is likely to begin cutting interest rates soon. He pointed to signs of economic slowdown and easing inflation pressures as key factors behind this anticipated shift in the Fed’s policy.

As of the time of this writing, Fed Funds Futures are pricing in 32, 69, and 107 basis points (bps) of rate cuts by FOMC’s meetings on September 18th, November 7th, and December 18th, respectively. However, the Fed’s own projections (“Fed’s Dot Plot”) indicate just one quarter-point cut by year-end, prompting some market pundits to call out that market expectations may be ahead of the Fed.

Membership in FHLBank San Francisco provides access to funding solutions that allow you to effectively manage your interest rate and liquidity risks while taking advantage of this changing interest rate dynamic.

FHLBank San Francisco Funding Solutions

Benefit immediately from falling interest rates with an Adjustable Rate Credit Advance
Adjustable Rate Credit (ARC) advances are priced at a pre-determined spread to the Secured Overnight Financing Rate (SOFR) and reset daily. This funding option allows you to shorten liability duration on your balance sheet and benefit from falling interest rates immediately. ARC advances are also great tools for match-funding floating rate assets and locking in a desired Net Interest Margin (NIM).

Secure more predictable funding costs and benefit from falling rates with a Fixed Rate Credit Advance
Take advantage of declining interest rates through short- or medium-term Fixed Rate Credit (FRC) advances. By structuring a ladder of these advances, your institution can secure a more predictable funding cost compared to floating rate options, shielding them from daily rate fluctuations. Additionally, this strategy enables you to benefit from falling rates as shorter-term advances mature and you have the option to either refinance advances at lower rates or replace them with lower cost deposits.

Coming Soon: Protect future liquidity positions and address potential regulatory pressures with the Fixed-to-Float Convertible Option Advance
FHLBank San Francisco will soon be providing a new advance product – the Fixed-to-Float Convertible Option Advance – for members who are looking to protect your future liquidity position and address potential regulatory pressures with term-certain funding, while taking advantage of attractive pricing in the short term. Like a Putable Advance, while in the lockout period, the Fixed-to-Float Convertible Option Advance starts out with a fixed coupon. The coupon is lower than a like-term Fixed Rate Advance because you sell an option (or a series of options if using Bermudan style option) to FHLBank San Francisco, giving FHLBank San Francisco the ability to convert the advance to a floating rate when interest rates may be higher. However, unlike a Putable Advance, you no longer need to worry about term uncertainty and associated regulatory scrutiny, because funding is guaranteed until the maturity of the advance.

From a pricing perspective, the fixed rate on a Fixed-to-Float Convertible Option Advance is generally higher than a like-term Putable Advance because FHLBank San Francisco guarantees funding for the full term of the advance. However, the coupon is still lower than a comparable-term FRC Advance, therefore offering an attractive opportunity to lock in lower cost of funds during the initial lockout period and potentially beyond, depending on future interest rates. 

More Products in Development
FHLBank San Francisco strives to deliver funding solutions that address your interest rate and liquidity risk needs in various economic cycles. One of those solutions currently in the development phase is a SOFR ARC advance with an embedded interest rate floor that you sell to FHLBank San Francisco. This new advance is intended to provide you with adjustable rate funding that is cheaper than a like-term SOFR ARC advance because the member sells an option to FHLBank San Francisco and agrees to floor the advance rate at a pre-determined level that the member chooses. Members looking to fund adjustable rate assets with similar cash flows (e.g. loans with embedded floors) or to lower their funding costs in a declining NIM environment might particularly benefit from this new product.

FHLBank San Francisco is eager to hear your feedback regarding how these new structured advance products could help you better manage your interest rate and liquidity risk. Please contact your Relationship Manager to learn more or share how your institution might benefit from these upcoming new product launches.

Case Study: Comparing Funding Strategies Under Alternative Rate Scenarios
Markets currently expect short-term rates to decline by almost 250 bps over the next three years. We create alternative interest rate scenarios by shocking these expectations up and down. We then calculate average cost of funds (COF) for different advance funding strategies over the three-year period. Specifically, we compare the COF of the three-year FRC bullet advance, three-year SOFR ARC advance, and an equal-weighted ladder of one-, two-, and three-year FRC advances.

Under the base case scenario implied by today’s SOFR forward curve, as one might expect, all three strategies produce very similar COFs as fixed-rate advances already price in all future rate cuts. However, if the Fed cuts rates more aggressively, the ARC strategy would produce the lowest COF as it reprices fastest of the three. Similarly, the FRC ladder would outperform the bullet FRC advance as the ladder provides the opportunity to refinance maturing tranches at lower rates. Conversely, if rate cuts materialize more slowly than what markets imply today, the bullet FRC advance would produce the lowest COF as its price would have reflected deeper rate cuts than realized. Likewise, an FRC ladder would outperform the ARC advance as inclusion of longer-dated tranches in the ladder would provide you with the opportunity to take advantage of today’s inverted yield curve and lock in lower rates.

To Learn More

Given the changing interest rate environment, it is essential to prepare your balance sheet for various economic outcomes. FHLBank San Francisco is focused on providing a comprehensive suite of credit products and solutions to help you effectively manage your interest rate and liquidity risk. If you want to learn more about member services and solutions from FHLBank San Francisco, please contact your Relationship Manager or the Member Services Desk at (415) 616-2500.

FHLBank San Francisco Membership Also Benefits Communities

FHLBank San Francisco makes a portion of its net income available through grants to finance the purchase, construction, or rehabilitation of housing for low- or moderate- income households in member communities. Utilizing FHLBank products to prepare your balance sheet could result in more financing available for housing needs in your communities.