In 2018, we saw increased interest in managing interest rate risk through a variety of interest rate derivative products.
Long-term rate increases continued last year from their absolute historical lows seen in mid-2016. The 10-year LIBOR (taxable) swap rate reached a peak of 3.29% and municipal swap rates moved similarly, with the 10-year SIFMA swap rate reaching a 5-year relative high of 2.48% in November 2018. Increases like these presented opportunities for some issuers with pre-crisis swaps to finally unwind these transactions as part of a fixed rate refunding.
Municipal issuers and borrowers also showed renewed interest in executing new swaps and caps for synthetically fixing-out new money deals and establishing rate lock strategies for anticipated debt issuance. Moreover, interest rate derivatives continued to be a cost effective way to mitigate future interest rate risk.
As of December 12, 2018, the mid-market cost of hedging a 10-year bullet maturity for 12 months with a SIFMA swap was approximately 1 basis point or .01% (excluding transaction expenses). The long-term historical average has been 1-2 basis points per month, while a forward bond delivery averaged approximately 5-6 basis points per month. We expect this opportunity to last if the shape of the yield curve is unchanged, continues to flatten, or inverts on the short end.
COMMODITY HEDGING
Liquid fuel prices increased in 2018 compared to 2017 averages, while natural gas prices remained effectively the same. According to the U.S. Energy Information Administration (EIA), retail gasoline prices per gallon rose to an average of $2.73 in 2018 from $2.42 in 2017. Retail diesel prices rose to $3.17 in 2018 from $2.65 in 2017. Natural gas average prices dropped only $0.02/mcf to $10.84 in 2018.1
Large governmental purchasers of liquid fuels and natural gas continued to use commodity futures, options, and derivatives (swaps, caps, and collars) as part of their fiscal policy tools. For these entities, commodity-hedging strategies are part of a risk management program to mitigate unexpected spikes in energy prices. Hedges also provide a level of price certainty that makes budgeting easier.
For 2019, the EIA projects decreases in annual average gasoline and diesel prices to $2.50 and $2.95/gal, respectively. Conversely, the EIA expects natural gas to rise an average of $11.24/mcf in 2019, compared to $10.84 in 2018.
BOND PROCEEDS INVESTMENT
As short- to medium-term interest rates increased throughout 2018, opportunities to invest project or construction funds grew. Many banks and dealers are reentering the REPO and GIC (unsecured) market as broader interest rates increase and credit conditions improve.
The 2- and 3-year U.S. Treasury rates increased from a low of 1.88% and 1.97% to a high of 2.97% and 3.04%, respectively. At the beginning of December, the U.S. Treasury curve began to invert between the 3- and 5-year maturities causing many issuers kept their investments short-term (1-3 years) until further steepening occurs. The U.S. 2-10 year spread diminished throughout the year, so typically longer-term investments were invested in shorter maturities.
With the Tax Cuts and Jobs Act and the elimination of tax-exempt advance refundings, most escrow open market securities investments were limited to within 90 days.
1At December 11, 2018