Banking industry stress prompts Fed intervention

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Treasury yields whipsaw in volatile week

• After touching recent highs early in the week, Treasury yields fell sharply due to contagion fears stemming from two U.S. bank closures.

Interest rate hedging activity extremely elevated

• Banks and customers alike looked to lock in current rates in both directions, depending on their risk position.

Federal Reserve unveils Bank Term Funding Program, U.S. Treasury guarantees closed banks’ deposits

• The Federal Reserve and U.S. Treasury took emergency measures over the weekend to stem the fallout of two large U.S. bank closures.

Treasury yields whipsaw in volatile week

• Short-term treasury yields reached higher during the first half of the week as Fed Chair Jerome Powell’s hawkish testimony in front of Congress added credence to the “higher-for-longer” narrative.
  • In semi-annual appearances before the Senate Banking Committee and the House Financial Services Committee, Chair Powell suggested that the peak level of the Fed’s policy rate “is likely to be higher than previously anticipated” and noted that the Fed “would be prepared to increase the pace of rate hikes” if incoming data warranted such a move.
  • Powell’s comments sent Fed Funds forward rates higher in the wake of the testimony, and market participants began pricing a 50 basis point hike at the March 22 Fed meeting as the most likely scenario.
• Treasury yields reversed course substantially on Thursday and Friday, however, after California state regulators shuttered a major tech-focused U.S. financial institution with substantial deposit outflows.
  • The two-year treasury ended the week at 4.60%, 26 basis points below where it began the week, while the 10-year yield fell 27 basis points to finish at 3.70%.
• Market expectations for Fed policy action whipsawed during the week, and market expectations as of Friday place the greatest odds on a 25 basis point hike at the scheduled March 22 FOMC meeting.
  • Market expectations shifted moderately lower for the next quarter’s worth of FOMC meetings, but expectations for the policy rate at the start of 2024 fell more sharply, declining 65 basis points since the start of last week.
• Treasury yields continued to fall in early Monday trading as market participants digested and assessed the impact of an emergency lending facility created by the Federal Reserve on Sunday aimed at providing support to U.S. financial institutions and hoping to restore public confidence in the financial system.

Interest rate hedging activity extremely elevated

• Hedging activity remained very robust last week as clients looked to fine-tune their interest rate risk positions in the face of elevated volatility.
• As noted previously, a more balanced level of hedging activity has emerged in recent weeks, with asset-sensitive institutions hedging floating-rate loans and fixed-rate debt portfolios and liability-sensitive institutions locking in the cost of new wholesale funding or shortening the duration of the fixed-rate asset portfolio.
• The dramatic fall in market rates on Friday enticed many borrowers in the back-to-back programs to accelerate their plans to hedge as they looked to take advantage of lower rates.
  • With five- and 10-year rates at their lowest levels in over a month, borrowers looked to exploit current market pricing before rates potentially rise again.
  • In particular, those with existing floating rate debt and those nearing loan closing moved quickly to capitalize.

Federal Reserve unveils Bank Term Funding Program, U.S. Treasury guarantees closed banks’ deposits

• After state regulators shuttered two large U.S. financial institutions in recent days, the Federal Reserve unveiled the Bank Term Funding Program (BTFP) on Sunday.
  • According to the Federal Reserve, the BTFP will allow U.S. financial institutions to access an additional source of funding for up to one year and will “help assure banks have the ability to meet the needs of all their depositors.”
  • Notably, the qualifying securities used as collateral for the borrowings will be valued at par rather than at current market levels, a head-turning move aimed at reducing the risk of the severe liquidity issues that plagued the two now-closed U.S. financial institutions.
  • Additionally, up to $25 billion from the Exchange Stabilization Fund will be made available as a “backstop” to the BTFP.
• Separately, the U.S. Treasury and the Federal Reserve announced in a joint statement on Sunday afternoon that all depositors “will be made whole” at each of the closed financial institutions and that “no losses will be borne by the taxpayer.”
• The measures taken over the weekend by the Federal Reserve and U.S. Treasury are intended to promote stability in financial markets, and financial markets have reacted positively to the news, with U.S. equity futures turning green.
  • The situation remains very fluid, and the Federal Reserve Board of Governors will hold an emergency meeting on Monday.

The look forward

Upcoming economic data releases

• Consumer Price Index – Tuesday
• Producer Price Index – Wednesday
• Empire Manufacturing Index – Wednesday
• Retail Sales – Wednesday
• Jobless Claims – Thursday
• Housing Starts – Thursday
• Philadelphia Fed Business Outlook Survey – Thursday
• Industrial Production – Friday
• Leading Index – Friday
• University of Michigan Consumer Sentiment - Friday

Upcoming Federal Reserve Speakers

• Emergency Federal Reserve Meeting – Monday
• Bowman – Tuesday

Rates snapshot

Market implied policy path (overnight indexed swap rates)