DOCSLIB.ORG

Credit Ratings and the Auditor's Going

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Credit Ratings and the Auditor's Going CREDIT RATINGS AND THE AUDITOR’S GOING- CONCERN OPINION DECISION ABSTRACT This study addresses the question whether credit ratings are considered in auditors’ going- concern assessments. Given credit rating agencies’ private information access, experience and expertise, I predict that credit ratings and especially credit rating downgrades contain incremental information for auditors’ going-concern opinion (GCO) decisions. Furthermore, I investigate if the association between credit rating and GCOs, and credit rating downgrades and GCOs varies as a function of local auditor industry specialization. Based on a sample of financially distressed, U.S. public companies with Standard and Poor’s credit ratings between 2000 and 2011, I find evidence of a strong association between credit ratings and the probability of auditors issuing a GCO. In particular, companies experiencing rating downgrades are more likely to receive a GCO, and specifically more recent and more severe downgrades are associated with a higher probability of a GCO. Finally, I find modest evidence that the association between credit ratings and GCOs differs between local auditor industry specialists and non-specialists. Overall, the results are consistent with the view that credit ratings provide incremental information to auditors. Keywords: going-concern audit opinion; credit rating (changes); auditor industry specialization 2 INTRODUCTION Since the recent financial crisis, the creditworthiness of companies and the likelihood to survive in the near future are in the spotlight again as an issue of concern for stakeholders, academics and regulators. Two parties that can issue a public warning signal on the financial situation of a company are external auditors and credit rating agencies. Surprisingly, however, to the best of my knowledge, prior research has not examined the relationship between the issuance of a going-concern opinion (GCO) and companies’ credit ratings. In this study, I examine the influence of credit rating levels and changes on the auditor's propensity to issue a going concern opinion. I expect and find that worse credit ratings are associated with a higher likelihood of auditors issuing a GCO. Moreover, auditors are more likely to issue a GCO if credit ratings have recently been downgraded. I also analyze if these associations vary as a function of auditor industry specialization. Consistent with the view that auditors incorporate the information content of credit ratings, I find a strong association between credit rating levels as well as credit rating downgrades and the probability of auditors issuing a GCO. These results contribute to the recent discussion on auditor’s GCO decision as well as potential regulatory changes with respect to auditing as well as credit rating agencies. Once a year, shortly after fiscal year-end, auditors issue the audit report, which states whether the auditor assesses the going-concern assumption as valid. Either the company receives a clean report and is expected to survive the next year, or the auditor expresses doubts that the firm will survive the next year by issuing a GCO. Credit rating agencies report on the creditworthiness of the obligor (Standard & Poor’s 2012). Contrary to audit reports, credit ratings can be updated at any time during the year and credit ratings are measured on ordinal scales, ranging from AAA, i.e. extremely strong capacity to meet financial obligations, to D, 3 which indicates default. Given that credit rating agencies monitor their ratings on an ongoing basis (Standard & Poor’s), credit ratings are expected to be adjusted on a timelier basis than audit reports. Investors are particularly concerned about information on whether a company is in financial distress and whether it faces the risk of bankruptcy. Although the issuance of a GCO is not intended to be a prediction of bankruptcy (AICPA 1993), “investors appear to expect the auditor to provide them with a warning of approaching financial failure” (Chen and Curch 1996, 118). Likewise, stakeholders and particularly creditors expect credit rating agencies to adjust the company’s credit rating to reflect the risk of approaching bankruptcy. Since both audit reports and credit ratings are perceived as indicative of potential financial failure, are publicly available and entail credible information (Blay et al. 2011; Ederington and Goh 1998), I examine if credit ratings and credit rating downgrades are related to auditors’ decisions to issue GCOs. I expect to find a positive association between worse credit ratings and GCOs and credit rating downgrades and GCOs for several reasons. First, credit rating agencies could be considered third-party specialists from whom auditors could derive information because companies are allowed to share private information with credit rating agencies without having to disclose it publicly (e.g., SEC 2000; Jorion et al. 2005; Poon and Evans 2011). Given that credit rating agencies are specialized, they are likely better at identifying relevant facts, analyzing these and drawing conclusions. Second, the decision to issue a GCO is rather sensitive (Carcello, et al. 2009) and credit ratings may play a role in this decision. Theory predicts that auditor reporting behavior is influenced by the perceived consequences in terms of expected costs of losing a client, being exposed to third-party lawsuits, and loss of reputation (e.g., Carcello and Palmrose 1994; Krishnan and Krishnan 1997; Vanstraelen 2003). Specifically, Matsumura et al. (1997) 4 present a model of the auditor’s going-concern decision which shows that a potential penalty associated with issuing an incorrect opinion affects the auditors’ expected payoff of issuing a GCO. Ignoring publicly available information is likely to increase this penalty. Hence, this study argues that auditors – who tend to be conservative – are unlikely to ignore public information on the financial condition of a company such as credit ratings, or credit rating changes. In addition to analyzing whether there is an association between credit ratings and GCOs, this study also considers whether this association varies as function of auditor competence, a key driver of audit quality (DeAngelo 1981). Auditors who are industry specialists are arguably more competent to assess the going-concern status of a client company within their specialization compared to non-specialists (e.g., Lim and Tan 2008; Reichelt and Wang 2010 1). Credit rating agencies do not have an irreproachable reputation (e.g. Wyatt 2002) and given auditor industry specialists’ own expertise, auditor industry specialists may reach a different conclusion than credit rating agencies, resulting in a weaker association between credit ratings and GCOs for industry specialists. Examining a sample of financially distressed U.S. firms who were audited between 2000 through 2010 and had a Standard & Poor’s (S&P) credit rating outstanding during this time period, this study finds a positive and significant association between credit ratings and the likelihood of receiving a GCO. 2 Specifically, having non-investment grade credit ratings and credit downgrades prior to the audit report significantly increase the likelihood of a GCO for 1 In his working paper, Minutti-Meza (2011) argues that Reichelt and Wang’s findings are actually attributable to differences in client characteristics and the resulting decision to hire a specialist or non-specialist auditor. 2 Credit ratings are coded in reverse order so that the best credit rating is associated with the lowest numerical value, i.e. from AAA (1) to D (10). 5 financially distressed firms. There is some evidence indicating that GCOs of local auditor industry specialists are less sensitive to credit ratings than non-specialists, consistent with specialist auditors relying on their own expertise over that of credit rating agencies. These findings contribute to the already substantial body of research investigating the determinants of the likelihood of a GCO (see Carson et al. 2012 for a review) and may also be of interest to regulators. BACKGROUND The Auditor’s Going-Concern Decision The audit report is the primary means by which auditors communicate information to stakeholders. During the audit, the assumption is made that the audited entity is able to survive in the foreseeable future, i.e. one year beyond the date of the financial statements being audited (AICPA 1972). If auditors find that this going-concern assumption is violated, they are required to modify their going-concern opinion (GCO) (AICPA 1988). Investors value GCOs and alter the market valuation of companies significantly if a GCO is issued (e.g., Blay et al. 2011), consistent with interpreting it as a warning signal of approaching bankruptcy (Chen and Church 1996). Matsumura et al. (1997) developed a model of the economic consequences associated with the going-concern decision to the auditor. They examine two scenarios in which the auditor’s decision might be wrong. First, the auditor might issue a GCO, which is ex post identified as incorrect (Type I error). Secondly, the auditor might make a Type II error, i.e. issue a clean opinion, which is revealed ex post to be incorrect when the client fails. Audit reporting errors 6 usually result in reputational losses and can be quite costly to auditors due to client loss and loss of future quasi rents or potentially high litigation costs (e.g., Carcello and Palmrose 1994; Krishnan and Krishnan 1997, Vanstraelen 2003). Given the associated costs, the decision to issue a GCO is quite sensitive (Carcello et al. 2009). The auditor’s decision to issue a GCO is particularly complicated in situations that require the assessment of highly complex or subjective matters. In these situations, auditors or auditees can request assistance from a third-party specialist, i.e. a “person or firm possessing special skills or knowledge in a particular field other than accounting or auditing” (PCAOB 1994). The audit process benefits in many ways from using specialists: First, evidence obtained from an independent, knowledgeable source is deemed more reliable (PCAOB). Second, third party specialists may have access to different information than the auditor.
Load more

Recommended publications
  • Going Concern Considerations and Recommendations(PDF)
    PCAOB Investor Sub Advisory Group GOING CONCERN CONSIDERATIONS AND RECOMMENDATIONS March 28, 2012 Auditing standards requiring auditors to issue going concern opinions have existed for several decades. However, research indicates the success with this standard has been somewhat spotty at best. Our experiences, including as signing audit partners, has been that it takes a significant amount of time, to carefully analyze a company’s financial condition, liquidity and results of operations when objectively trying to determine if the company is going to last another year or not. The one year from the balance sheet date has been a very clear standard auditors’ and companies fully understand. However, when a significant event would be due to occur shortly after that 12 month period, such as a major debt refinancing being due, or a major customer or vendor supply agreement concluding, it did make one nervous looking to just a twelve month period. Auditors will typically look at historical results in the last few years, especially trends in the last half and quarter of the year. That would include revenue trends, cash sources and uses, available cash and funding sources, etc. The auditor would look at budgets and projections for the next year, and require management to provide, and go over, their projections and key assumptions going into those projections. The auditor would try to get a handle on the risks in those projections and what things could go awry that would result in more negative results, than were being projected. More difficult for the auditor was getting data on the industry, competitors and economy and how they would affect a company’s financial stability.
    [Show full text]
  • The Role of Audit and Credit Rating Agencies in the Assessment of Company Creditworthiness with Special Focus on Banks Udc 657.6:347.734
    FACTA UNIVERSITATIS Series: Economics and Organization Vol. 16, No 1, 2019, pp. 89 - 101 https://doi.org/10.22190/FUEO1901089J Review Paper THE ROLE OF AUDIT AND CREDIT RATING AGENCIES IN THE ASSESSMENT OF COMPANY CREDITWORTHINESS WITH SPECIAL FOCUS ON BANKS UDC 657.6:347.734 Mirjana Jemović, Milica Đorđević, Jelena Radojičić Unversity of Niš, Faculty of Economics, Niš, Serbia Abstract. Audit and credit rating agencies have a significant responsibility in assessing company creditworthiness and giving opinions on the client’s ability to continue business in the future, most often the next fiscal year. Responsibility is even greater when it comes to banks and their creditworthiness. The financial crisis of 2007 and the bankruptcy of a number of banks and other financial institutions imposed a need to seek accountability for the “delayed” reaction of regulatory bodies and significant fiscal consequences of the crisis. The aim of the paper is to evaluate the efficiency of credit rating agencies and external audit in assessing the creditworthiness of companies and banks, not for the purpose of finding their individual responsibilities, but to look at possible coordinated and joint actions to prevent future crisis events. Key words: credit rating agencies, external audit, creditworthiness, financial crisis JEL Classification: G21, G24, G28, M42, M48 INTRODUCTION Investors make investment decisions based on information they have about company creditworthiness. For these reasons, companies listed on the stock market are obliged to report on their operations by publishing their financial statements. In order to reduce information asymmetry between issuers of securities and investors, numerous bodies and agencies assess company creditworthiness.
    [Show full text]
  • Credit Rating Changes & Auditor Reporting Accuracy
    CREDIT RATING CHANGES & AUDITOR REPORTING ACCURACY NADINE FUNCKE Maastricht University P.O. Box 616, 6200 MD Maastricht The Netherlands [email protected] Draft March 2014 Please do not distribute or quote without permission by the author Author Note: I thank Ann Vanstraelen, Robert Knechel, Frank Moers, Caren Schelleman & Han Stice for helpful comments. 1 CREDIT RATING CHANGES & AUDITOR REPORTING ACCURACY ABSTRACT This study addresses the question whether credit ratings are associated with auditor reporting accuracy. Given credit rating agencies’ private information access, experience and expertise, I examine whether the presence of poor credit ratings and especially credit rating downgrades contain incremental information for auditors’ going-concern opinion (GCO) decisions that improve auditors’ GCO decisions. Furthermore, I investigate if the association between credit rating downgrades and auditor reporting errors varies as a function of auditor specialization. Based on a sample of financially distressed U.S. public companies with Standard and Poor’s credit ratings between 1999 and 2012, I find that poor credit ratings significantly increase Type I errors, but do not decrease Type II errors. However, credit rating changes and particularly more severe and more recent rating downgrades are associated with a higher (lower) probability of Type I (Type II) errors. Finally, I find weak evidence that auditors clearly not specialized in their client’s industry are less conservative but that credit rating downgrades reduce their Type II reporting error rate. Overall, the results imply that credit ratings function as external warning signals that increase auditor conservatism. Keywords: going-concern reporting errors; credit rating (changes); auditor industry specialization 2 INTRODUCTION This study investigates the relationship between credit ratings and going concern reporting misclassifications.
    [Show full text]
  • Time for Companies to Have a Financing Check-Up Whilst the Black Swan Is Circling [Brought to You by Gibson Dunn]
    MAR 13, 2020 | BY MICHAEL NICKLIN JAMIE THOMAS Coronavirus: Time for Companies to have a Financing Check-up whilst the Black Swan is Circling [Brought to you by Gibson Dunn] COVID-19 could be the black swan that has devastating effects on the global economy. Concerns over the impact of the virus have caused significant volatility in the stock markets over the last few weeks and the potential scale of the impact across a very wide range of industries is just beginning to be realised. Now is the time to be checking your financing documents to fully understand how COVID-19 might impact your operations and financial results and your ability to remain in compliance. If you are a borrower in the Asia-Pacific region, this article is particularly relevant to you. Key areas you should be focusing on include: FINANCIAL COVENANTS/EQUITY CURE/COVENANT RESET In most markets in the Asia-Pacific region, loan facilities typically still have two or three maintenance financial covenants. Given the myriad of ways that a public health emergency like COVID-19 can affect businesses, and the scale of the impact, it seems inevitable that the virus will cause some companies to breach these financial covenants. The threshold questions then become which covenants will be breached, when will they be breached and what steps can companies take to address the problem. Business Interruption Insurance In determining whether a covenant breach is likely, it is worth first carefully considering whether there is business interruption insurance in place that will cover the losses incurred by a company.
    [Show full text]
  • International Standard on Auditing (ISA) 570, “Going Concern”
    International Exposure Draft Auditing February 2007 and Assurance Comments are requested by May 31, 2007 Standards Board Proposed Redrafted International Standard on Auditing ISA 570, Going Concern REQUEST FOR COMMENTS The International Auditing and Assurance Standards Board (IAASB), an independent standard- setting body within the International Federation of Accountants (IFAC), approved the exposure draft, proposed International Standard on Auditing (ISA) 570 (Redrafted), “Going Concern,” for publication in February 2007. This proposed ISA may be modified in light of comments received before being issued in final form. Please submit your comments, preferably by email, so that they will be received by May 31, 2007. All comments will be considered a matter of public record. Comments should be addressed to: International Auditing and Assurance Standards Board International Federation of Accountants 545 Fifth Avenue, 14th Floor New York, New York 10017 USA Comments should be emailed to [email protected]. They may also be faxed to +1-212-286- 9570 or mailed to the above address. Copies of the exposure draft may be downloaded free-of-charge from the IFAC website at http://www.ifac.org. Copyright © February 2007 by the International Federation of Accountants. All rights reserved. Permission is granted to make copies of this work to achieve maximum exposure and feedback provided that each copy bears the following credit line: “Copyright © February 2007 by the International Federation of Accountants. All rights reserved. Used with permission.”
    [Show full text]
  • Quick Reference Guide Standards and Premises of Value
    Forensic and Valuation Services Section Quick reference guide Standards and premises of value Overview of guide Primary premises of value Other premises of value Other valuation considerations Standards of value Standards of value under special circumstances Notes Overview of guide The AICPA’s “General Standard Rule” (AICPA, Professional The primary purpose of this quick reference guide is to Standards, ET sec. 1.300.001 and 2.300.001),1 states that a provide an overview of the relevant premises and standards member shall “undertake only those professional services of value used in valuations, and to assist the valuation that the member or the member’s firm can reasonably expect professional with understanding those differences. to be completed with professional competence.” Performing a valuation engagement with professional competence involves special knowledge and skill. Statement on Standards for Valuation Services No.1 states that a valuation professional should consider, at a minimum, the scope of the valuation engagement, including applicable standard of value (for example, fair value or fair market value), and the applicable premise of value (for example, going concern) when completing a valuation engagement. 1 Formally Rule 201, General Standards. Back to top Overview of guide Primary premises of value Other premises of value Other valuation considerations Standards of value Standards of value under special circumstances Notes Primary premises of value The International Glossary of Business Valuation Terms (“Glossary”) defines premise of value as “an assumption regarding the most likely set of transactional circumstances that may be applicable to the subject valuation.” Two main premises of value in business valuation: A.
    [Show full text]
  • Is There Any Effect of Going Concern Audit Opinion Public Announcements on the Stock Price Behavior in a Short Term Period?
    Is there any effect of going concern audit opinion public announcements on the stock price behavior in a short term period? Empirical evidence from Australia Authors: Mariya Novoselova Nhar Soklim Supervisor: Tobias Svanström Student Umeå School of Business Spring semester 2011 Master thesis, two-year, 30 hp Acknowledgements We would like to take the occasion to express a profound gratitude to our supervisor Tobias Svanström for the valuable advice, constructive criticism and overwhelming helpfulness. It was a great pleasure to discuss our research problem with him and gain new insights while conducting the study. Therefore, we are deeply indebted to Tobias for his dedication and willingness to share the professional knowledge with us. Furthermore, we are grateful to the persons from the Department of Statistics, more specifically Mojgan Padyab and Anders Lundquist, who helped us with a piece of advice on the event study statistic methods. Also we acknowledge the contribution to our academic and personal development on the part of the USBE professors from the previous courses. With all my heart I, Mariya Novoselova, wish to thank Umeå University, in particular, and Sweden, as a country in general, which have provided me with the unique opportunity and challenge to study here. Also it worth mentioning how thankful I am to my home country Russia and professors from Perm State University, who created a fundament for my “grain” of knowledge. I have no words to express the gratitude and love to my family, the parents Ludmila Novoselova and Nickolai Novoselov, and brother Maxim Novoselov, since their encouragement and inevitable support made this rewarding experience possible.
    [Show full text]
  • The Impact of a Going-Concern Audit Opinion on Board of Directors
    Journal of Corporate Governance, Insurance, and Risk Management (JCGIRM) 2016, Volume 3, Series 1 Pages 87-96 The Impact of a Going-Concern Audit Opinion on Board of Directors Igor Todorovića, Jelena Poljaševića a University of Banja Luka, Faculty of Economics, Banja Luka, Bosnia and Herzegovina A B S T R A C T A R T I C L E I N F O Paper examines the impact of a going-concern audit opinion on the Keywords: corporate governance, measured by the changes in board of directors’ Audit, Board of Directors, composition. External auditor’s opinion is used as a measure to address Corporate Governance, Going- agency problems in companies. We examine this impact on sample of 55 Concern Opinion companies listed on the Banja Luka Stock Exchange which have received going-concern audit opinion for 2013 financial reports. In this paper, the *Corresponding author: relationship between going-concern audit opinion and the corporate [email protected] governance is investigated observing changes in board of director (Igor Todorović) composition and additional requests for rigorous board performance evaluation after the shareholder’s assembly have received external Article history: auditor’s report. Results show that board of directors of companies that received going-concern audit opinions have not suffered serious Article Submitted 10-04-2016 consequences such as rigorous board performance evaluation, reduction of Article Accepted 25-06-2016 board size or changes of board members. This highlights the importance of **Article previously published in measures that need to be put in place in order to increase of external EJEM 2016, vol 3, No.
    [Show full text]
  • Relationship Between Audit Opinion and Credit Rating
    The Journal of Applied Business Research – March/April 2016 Volume 32, Number 2 Relationship Between Audit Opinion And Credit Rating: Evidence From Korea Myungki Cha, Sogang University, South Korea Kookjae Hwang, Sogang University, South Korea Youngjun Yeo, Sogang University, South Korea ABSTRACT In this study, we investigate the relationship between credit ratings and audit opinions of financially distressed companies impending bankruptcy. Using Korean publicly-held firms for the years 2007 through 2014, we analyze 97 bankrupt companies with credit rating available before they file bankruptcy. Following prior research (Geiger et al., 2005), we find that the propensity to issue a going concern audit opinion is associated with the credit score issued by NICE immediately prior to the audit opinion date. We also compare credit ratings to audit opinions to investigate which of the two is more conservative and provides the earlier signal of bankruptcy. Through empirical test, we can conclude that audit system has more successfully predictive function in signaling preceding bankruptcy than CRAs' system with overly optimism. We argue that after a string of high-profile corporate failures such as Enron and Arthur Anderson’s bankruptcies, legislators portrayed auditors negatively and ultimately led to the enactment and more forced liabilities and thus auditors become more conservative. To remedy CRAs' failure by providing overly optimism, we suggest that like as auditors, CRAs' regulations should be more strengthened on their liability about issuing credit ratings. Keywords: Credit Rating; Going-Concern Opinion; Credit Rating Agency; Auditor 1. INTRODUCTION n this study, we investigate whether credit ratings influence audit opinions of financially distressed firms facing bankruptcy as well as which of the two is more conservative and provides more relevant information.
    [Show full text]
  • GUIDE to GOING CONCERN ASSESSMENTS Contents
    GUIDE TO GOING CONCERN ASSESSMENTS Contents INTRODUCTION � � � � � � � � � � � � � � � � � � � � � � � � � 1 FINANCIAL REPORTING FRAMEWORK � � � � � 3 DISCLOSURE REQUIREMENTS � � � � � � � � � � � � � 7 INTERNAL CONTROL OVER FINANCIAL REPORTING � � � � � � � � � � � � � � � � � � 8 GUIDE TO GOING CONCERN ASSESSMENTS 1 Introduction While particularly important in the wake of the COVID-19 pandemic, the evaluation of going concern is not new. Under generally accepted accounting principles in the United States, entities have been required to consider going concern since 2014 and auditors have been required under their professional standards to evaluate their client’s ability to continue as a going concern for much longer than that. In making this evaluation, significant judgment will be required as no two entities’ fact patterns, even if operating in the same industry, will be the same. At the end of the day, it will come back to one central question - will the company have sufficient cash flows to meet its existing obligations and alleviate any conditions that raise substantial doubt about its ability to continue as a going concern? 2 GUIDE TO GOING CONCERN ASSESSMENTS GUIDE TO GOING CONCERN ASSESSMENTS 3 Financial Reporting Framework In accordance with ASC 205-40, Presentation of Financial ASC 205-40 states that substantial doubt about an entity’s Statements — Going Concern, in preparing financial statements ability to continue as a going concern may exist when for each annual and interim reporting period, management current conditions and events, considered in the aggregate, must evaluate whether there are conditions and events that raise substantial doubt about whether the entity will be raise substantial doubt about an entity’s ability to continue able to meet its obligations as they become due within the as a going concern within one year after the date the financial assessment period.
    [Show full text]
  • The Auditor's Consideration of an Entity's Ability to Continue
    An Entity’s Ability to Continue as a Going Concern 2047 AU Section 341 The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern* Source: SAS No. 59. See section 9341 for interpretations of this section. Effective for audits of financial statements for periods beginning on or after January 1, 1989, unless otherwise indicated. .01 This section provides guidance to the auditor in conducting an audit of financial statements in accordance with generally accepted auditing stan- dards with respect to evaluating whether there is substantial doubt about the entity's ability to continue as a going concern.1,2 Continuation of an entity as a going concern is assumed in financial reporting in the absence of significant information to the contrary. Ordinarily, information that significantly contra- dicts the going concern assumption relates to the entity's inability to continue to meet its obligations as they become due without substantial disposition of assets outside the ordinary course of business, restructuring of debt, externally forced revisions of its operations, or similar actions. The Auditor’s Responsibility .02 The auditor has a responsibility to evaluate whether there is substan- tial doubt about the entity's ability to continue as a going concern for a reason- able period of time, not to exceed one year beyond the date of the financial state- ments being audited (hereinafter referred to as a reasonable period of time). The auditor's evaluation is based on his or her knowledge of relevant conditions and events that exist at or have occurred prior to the date of the auditor's report.
    [Show full text]
  • Butterfield Money Market Fund Limited
    Butterfield Money Market Fund Limited FINANCIAL STATEMENTS FOR THE YEAR ENDED JUNE 30, 2019 Butterfield Money Market Fund Limited JUNE 2019 ANNUAL REPORT USD CLASS The favorable conditions of 2018 resulted in a 25 bps hike per quarter throughout the entire calendar year. The unemployment rate fell further below 4.0% from 12 months ago to the current 3.7% a level not seen in more than three decades. Inflation held below the 2.0% target but not so far as to cause deflation concerns, and GDP was still respectable. Yet, monetary policy was not based entirely on economic data in 2019. The Fed’s view of monetary policy began to shift away from the removal of stimulus towards an acknowledgement that rates were approaching a neutral level near the end of 2018. Consequently, the momentum changed in 2019 with the FOMC staying on hold for the entire first half. Therefore, the Fed Funds rate ended the financial year at a high of 2.25% – 2.50%. The 2018 hikes were a significant boost to the yields on the USD Class. Given the strong link between the Fed Funds rate and short-term rates, the Class A yield soared from 1.68% to 1.96% during the financial year. Average life hovered around neutral of 30 days. Initially, this strategy was employed to facilitate the quick pass through of the forthcoming rate hikes. By the second quarter of 2019, this strategy became a defensive one when the inverted yield curve signaled rate cuts were on the horizon. A-1+ rated securities, S&P’s top rating, floated in the range of 60%-70%.
    [Show full text]