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Market Update

CPI indicates persistent but slowing inflation

Date:
May 16, 2022
  • william smith headshot

    Authors

    Bill Smith

    Associate Director
    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA

Summary

Risk-off activity continued last week as Treasury yields, particularly at the long-end, and the major U.S. equity indices moved lower as investors digested the latest inflation readings and comments from Federal Reserve officials, including Federal Reserve Chair Jerome Powell.

Interest rates

  • After steepening significantly, the Treasury curve gave up some of those gains, flattening on the week, as the short-end of the curve remained mostly unchanged while the long-end moved notably lower as investors let out a sigh of relief as the latest inflation readings topped expectations but showed signs of easing.
    • The 2s/10s basis dropped to 33 basis points, down six basis points from the week prior, and the 10-year Treasury yield ended Friday at 2.93%, far from the multi-year high of 3.13% reached the previous Friday.
  • Inflation expectations dropped across the board last week with the Fed-watched five-year forward, five-year breakeven inflation rate falling sharply to 2.35% by Friday, approximately 15 basis points lower than where it started the week.
  • Market expectations for Fed rate hikes pulled back slightly after Fed Chair Powell reiterated comments he made after the last FOMC monetary policy meeting saying that 50 basis points hikes at the next two FOMC meetings would be appropriate “if the economy performs about as expected,” but cautioned that a soft-landing is “quite challenging to accomplish.”
    • Looking at Fed Funds futures pricing at the close on Friday, investors expect the Federal Funds Target Rate to reach 3% by February 2023.
  • Finally, real rates moved lower last week but have largely held the ground gained in recent weeks with the seven,10, 20, and 30-year real yields all sitting in positive territory.

                    Trading commentary

                    • The balance sheet hedging desk continues to experience a steady flow of transaction volume in both directions as clients look to hedge the balance sheet amid substantial market volatility.
                    • We have seen a pickup in conversations and executions related to OCI hedging strategies.
                      • The sharp run-up in rates since the turn of the year has prompted some clients to look to asset-hedging strategies as securities portfolios across the banking industry have seen notable declines in recent months.
                    • Down-rate hedging strategies remain the most popular however with clients often looking to the floating-rate loan portfolio as a host for a receive-fixed swap given the roughly 180 basis points of initial compensation afforded by these strategies and the desire to smooth earnings in the expected rising-rate environment.
                    • Finally, our back-to-back desk remains active as borrowers look to lock in long-term fixed-rate financing in the face of a decades-high inflationary environment and the most hawkish Federal Reserve in recent memory.
                      • Many borrowers have looked to get ahead of the LIBOR transition in recent weeks, proactively amending existing LIBOR-based contracts to alternative indices, primarily CME Term SOFR.

                                      Deposit and loan growth slow to start 2022

                                      • After a historic run-up in deposit balances for U.S. financial institutions across the country at the onset of the pandemic, deposit balance growth looks to be slowing as U.S. financial institutions reported a 1.2% growth in total deposits in the first quarter of 2022, the weakest growth rate since late 2020, according to S&P Capital IQ.
                                      • Total loan growth also appears to be slowing.
                                        • U.S. financial institutions reported a 1% increase in total loans in the first quarter compared to the 3% pace seen in the fourth quarter 2021.
                                      • Looking back to recent earnings commentary from some of the largest U.S. financial institutions, sentiment is generally positive for loan growth in the second quarter.

                                                                      Economic data

                                                                      • With a thin economic calendar for the week, all attention turned to inflation as last week brought the latest Consumer Price Index (CPI) and Producer Price Index (PPI) readings.
                                                                      • According to the Labor Department, consumer prices rose 8.3% since last April, modestly above the consensus estimate but below the 8.5% year-over-year increase seen in March.
                                                                        • Digging into the headline report, new vehicles, in addition to food and shelter costs, made up the primary drivers of the monthly CPI pickup.
                                                                      • Looking at the core measure, which excludes the often-volatile food and energy components, prices are up 0.6% in the last month, twice the monthly increase seen in March.
                                                                      • Producer prices also cooled in April, with the PPI showing prices rising 0.5% over the month, much slower than the 1.6% monthly increase seen in March.
                                                                        • Much of the headline PPI decline was a result of moderating energy prices, which rose 1.7% in April compared to the 6.4% increase seen in March on the back of Russia’s invasion of Ukraine.

                                                                          The look forward

                                                                          Upcoming economic data releases

                                                                          • Empire Manufacturing Index - Monday
                                                                          • Retail Sales - Tuesday
                                                                          • Industrial Production - Tuesday
                                                                          • Housing Starts - Wednesday
                                                                          • Building Permits - Wednesday
                                                                          • Philadelphia Fed Business Outlook Survey - Thursday
                                                                          • Jobless Claims - Thursday
                                                                          • Existing Home Sales - Thursday
                                                                          • Leading Index - Thursday

                                                                                                              Upcoming Federal Reserve speakers

                                                                                                              • Williams - Monday
                                                                                                              • Powell, Bullard, Harker, Kashkari, Mester, Evans - Tuesday
                                                                                                              • Harker - Wednesday
                                                                                                              • Kashkari - Thursday

                                                                                                                                                  Rates snapshot

                                                                                                                                                  Market implied policy path (Overnight indexed swap rates)

                                                                                                                                                  Source: Chatham Financial

                                                                                                                                                  About the author

                                                                                                                                                  • Bill Smith

                                                                                                                                                    Associate Director
                                                                                                                                                    Balance Sheet Risk Management

                                                                                                                                                    Financial Institutions | Kennett Square, PA


                                                                                                                                                  Disclaimers

                                                                                                                                                  Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

                                                                                                                                                  Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.

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