Earlier quoted context omitted.
Swaps do indeed transfer that risk to other parties, at a premium because those other parties are more able to absorb the risk. While, sure, there are systematic stresses across the whole financial system, it doesn't mean that there aren't counterparties more capable of managing interest rate risk and willing to do so for a fee. This can be done by just having a larger balance sheet, or blending durations. Seems like…
Who are these counterparties that can absorb trillions of dollars in interest rate risk? My amateur understanding is that this counterparty would need to be short long bonds, ie. be a bond issuer. And they would need to be interested in exchanging their fixed interest rate for a variable one. If the above is correctly understood I don't see how banks can find issuers of trillions of dollars worth of bonds that want a…
If I’m taking the variable end of a swap and expecting interest rate hikes, I can use the spread I’m gaining to offset the damage to a portfolio I already have of shorter duration (thus: less interest rate sensitive) bonds.
Overall, the USG issuing trillions of dollars of low interest bonds and then raising rates is going to cause losses for bond holders throughout the system, but as long as those bonds are held, in aggregate, in portfolios and entities which won’t face liquidity crises until they mature, the loss can be borne.
There may also be more sophisticated ways of offsetting bond exposure, but I’m not familiar. I’m appealing more to the idea that this impact by the Fed is easy to predict, indeed exactly the point. Bond valuations drying up will reduce the multiplier and take money out of circulation. The system is supposed to remain capitalized (and/or hedged) to survive the stress and the Fed would be watching. Apparently some parts of the system weren’t. And there are calls for the Fed to slow down. And probably more evidence that banking regs need to remain strong.