Lesson 22 of 25 · 7 min

Lags: why the effect arrives after the decision

Collateral reprices on the expectation and cost reprices on the realisation, which puts the two legs on clocks weeks apart.

A decision and its effects are separated by delays, and the delays are different lengths on each leg of a facility. Getting the order wrong is what makes a tightening feel like it arrived all at once at the end.

The collateral leg has almost no lag at all. A market price is a forward-looking number, so it moves when the expectation moves — which can be weeks before a decision is announced and is often complete before the announcement. The cost leg has several lags stacked on top of each other: an observation lookback of a few business days, a reset that occurs only on a schedule, and then a month of accrual before anything appears in print.

Follow one illustrative case. The market comes to expect a path 0.35 of a point higher. A $2,380,000 portfolio with an effective duration of 6.6 reprices by 6.6 × 0.35 = 2.31 percent, or $54,978, within that week. The facility's rate does not move until the next monthly reset, and the lookback means the index value used will be one observed five business days before it. On a $1,615,000 balance, the 23 days between the repricing and the reset accrue at the old rate — $361.13 of interest not yet charged at the higher figure.

So the sequence runs collateral first and cost second. That is the opposite of the intuitive order, in which the rate rise is the event and the consequences follow it. The event was the change in expectation, and the rate rise is one of the later consequences, not the first.

This lands squarely on what a borrower can observe. The statement covering the month in which the collateral moved will show the old rate, because the reset had not happened. The two legs are not merely on different clocks; the slower one is the only one reported at all.

Key terms

Transmission lag: The delay between a decision and its effect on a given market. Close to zero for prices that trade on expectations, and weeks or months for contractual rates.
Reset lag: The contractual delay before a changed index reaches a facility, made of an observation lookback plus the wait for a scheduled reset.
Reporting lag: The further delay before a change appears in print, since a statement closes after the period it describes.

Worked example

Two clocks on one change in expectations

An expected path 0.35 of a point higher. Portfolio $2,380,000 at an effective duration of 6.6, balance $1,615,000, Act/360, monthly reset with a five business day lookback.

Change in the expected path: 0.35 of a point
Collateral repricing, same week: −2.31%
In dollars: −$54,978
Days until the facility's next reset: 23
Interest not yet charged at the higher rate: $361.13
Order of arrival: Collateral first, cost second

The collateral leg landed in full within a week and the cost leg had not started. A borrower reading the statement for that month would see a rate that had not moved.

Check yourself

A decision is fully anticipated and then delivered exactly as expected. What happens to each leg of a facility on the day it is announced?

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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.