Big banks pass stress tests
- June 28, 2021
Balance Sheet Risk Management
Financial Institutions | Kennett Square, PA
Prior week summary
The major U.S. equity indices moved higher over the week with the S&P 500 and Nasdaq Composite Indices reaching new all-time highs amid a breakthrough in infrastructure negotiations, mixed economic data, and sustained improvement in the COVID-19 situation in the U.S. While the equity markets received much of last week’s attention as they set new records, the bond market continued the sell-off that ignited after the week prior’s FOMC meeting. The five-year U.S. Treasury yield rose approximately three basis points over the week, sitting at 0.92% late Friday, while the 10-year Treasury yield pushed up to 1.54% to end the week, nine basis points higher than where it began the week. Unsurprisingly, much of the increase in the 10-year yield came on the back of a rise in inflation expectations as the 10-year breakeven inflation rate climbed to 2.36% by the end of the week, a 12-basis point week over week increase. Market participants turned their attention to realized inflation last week as well with the Fed-preferred measure of inflation, the PCE Deflator, released on Friday. The latest PCE reading indicated that prices increased 0.4% in May, a moderation from the 0.6% pace seen in April. The yearly figure fell in line with expectations increasing 3.9%. Federal Reserve Bank of New York President John Williams signaled that there is no cause for alarm and argued that recent price increases are a function of an economy returning to normal saying, “Inflation should come down to around 2% next year and the year after. What we’re seeing now is people getting back on planes, going to hotels. Those prices are coming back. They’re coming back towards the levels they were before the pandemic, so it’s really just an adjustment back to normal.” On Thursday, the third estimate for first-quarter GDP came in at 6.4%, in line with expectations and reflecting the increased level of economic activity following the easing of COVID-19 restrictions across the country and trillions in fiscal stimulus. Second-quarter GDP may outpace that of the first quarter with the Atlanta Fed’s GDPNow forecast, which attempts to forecast the current quarter’s GDP in real time, calling for the U.S. economy to expand at an 8.3% pace in the second quarter. Lastly, jobless claims resumed their descent last week falling to 411,000 claims for the week of June 19, albeit above the consensus estimate.
After weeks of negotiations and numerous failed proposals, a bipartisan group of lawmakers along with President Biden agreed to an infrastructure bill that would allow for $579 billion in new spending directed at improving the country’s physical infrastructure, namely roads, bridges, and broadband. Under the current proposal, $312 billion would fund transportation initiatives, $65 billion allocated for increased broadband access, and $55 billion for water initiatives. The bill faces significant headwinds from the progressive wing of the Democratic Party with many members characterizing the bill as too small in both price and scope. President Biden also cast doubt on the bill’s prospects shortly after its unveiling saying that his signature depended on the passing of the American Families Plan and climate-based initiatives. On Saturday, the President walked back those claims and reiterated his support for the bill saying, “The bottom line is this: I gave my word to support the Infrastructure Plan, and that’s what I intend to do. I intend to pursue the passage of that plan, which Democrats and Republicans agreed to on Thursday, with vigor. It would be good for the economy, good for our country, good for our people. I fully stand behind it without reservation or hesitation.” While the deal appears to be back on track, the outcome remains very uncertain, and negotiations are expected to heat up in the coming week.
On Thursday, the Federal Reserve released the results of its annual bank stress tests, “which showed that large banks continue to have strong capital levels and could continue lending to households and businesses during a severe recession.” According to the statement released with the results, “All 23 large banks tested remained well above their risk-based minimum capital requirements and as laid out previously by the Board, the additional restrictions put in place during the COVID event will end. All large banks will be subject to the normal restrictions of the Board's stress capital buffer, or SCB, framework.” The results now set the stage for banks to raise dividends and resume stock buybacks, both of which were suspended during the pandemic.
The look forward
Market participants are gearing up for a very busy week of economic data releases with updated figures on the Conference Board Consumer Confidence Index, ADP employment report, construction spending, the ISM Manufacturing Index, and most notably, the June non-farm payroll report, among others, set for release. Several Federal Reserve officials hold speaking engagements throughout the week.
Market implied policy path (Overnight indexed swap rates)
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