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Market Update

CPI / PPI offer signs of easing inflation

Date:
August 15, 2022
  • william smith headshot

    Authors

    Bill Smith

    Associate Director
    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA

Summary

After weeks of substantial volatility, Treasury yields across the curve traded in a relatively tight range, moving modestly higher on the week, as investors digested last month’s inflation figures, the latest Federal Reserve commentary, and a hefty corporate earnings calendar.

Interest rates

  • After seeing significant week-over-week rate volatility for much of July and August, Treasury yields took a breather last week.
    • Last week’s rate movements were muted with the two-year Treasury yield moving three basis points higher to 3.25% and the 10-year Treasury yield moving one basis point higher to 2.84%
    • The curve flattened further last week, pushing the 2s/10s basis to levels not seen since 2000 at -0.42%.
  • Market participants’ expectations for Federal Reserve policy action remained mostly unchanged during the week.
    • Investors now see a lesser likelihood of a 75 basis point hike at the September FOMC meeting compared to the week prior.
    • Looking ahead to next year, market participants continue to price in a 25 basis point cut in the summer of 2023.
      • Minneapolis Fed President Neel Kashkari pushed back against the notion that the Fed would cut rates consistent with the market’s consensus expectation saying, “The idea that we’re going to start cutting rates early next year, when inflation is very likely going to be well in excess of our target—I just think it’s unrealistic.”
  • Despite the miss in the headline July Consumer Price Index figure, inflation expectations both in the midterm and in the long term remained mostly unchanged from the week prior.
    • Similar to the modest changes seen in nominal rates, real yields moved marginally last week with the five-year real yield declining three basis points to 0.30% and the 10-year real yield rising five basis points to 0.67%.

Trading commentary

  • As noted previously, downrate hedging strategies continue to see the lion’s share of executions crossing our balance sheet risk management desk.
    • While plain vanilla receive-fixed interest rate swaps continue to be the most popular derivative instrument used to achieve the economic objective, we have seen a notable rise in the execution of option-based products, particularly zero-cost collars.
  • Hedges designed to lock in or cap the cost of wholesale funding have also risen considerably in popularity over the last quarter as we hear reports from clients that deposit run off is materializing and the need for wholesale funding is rising.

Bank M&A activity slows down in the first half of 2022

  • Despite a similar number of transactions executed year-to-date (YTD) compared to 2021, 2022 deal value through July is down significantly compared to the year prior.
    • According to S&P Capital IQ, the aggregate deal value in 2022 totaled $17.58 billion YTD over 97 transactions, a far cry from the $38.59 billion seen over the same timeframe in 2021.
    • Looking at 2022 transactions, Toronto-Dominion Bank’s acquisition of First Horizon Corp. remains the largest in a deal valued at $13.67 billion.
  • Nonetheless, transactions continue to reach completion amid the uncertain economic outlook with 15 deals announced in July.

Economic data

  • Despite a packed economic calendar, market participants’ attention was mostly focused on Wednesday’s release of the Consumer Price Index (CPI) last week.
    • After surging to a four-decade high in June, inflation, as measured by the CPI, eased in July to an 8.5% annualized rate, below the consensus estimate that also called for a drop from June’s chart-topping figure.
    • A steep drop in energy prices coupled with a moderate decline in used vehicle prices led to the decline despite elevated food and rental costs.
    • The core measure, which excludes the often-volatile food and energy components, rose a modest 0.3%, well below the 0.7% monthly increase seen in June.
  • Thursday’s release of the Producer Price Index (PPI) further suggested that inflationary pressures are easing somewhat after the PPI declined 0.5% in July, the first monthly decline since the beginning of the pandemic in April 2020.
  • Finally, consumer sentiment appears to be stabilizing.
    • The University of Michigan’s Consumer Sentiment Index moved substantially higher in August, far above the consensus estimate and the levels seen in July.

The look forward

Upcoming economic data releases

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

Upcoming Federal Reserve speakers

  • George, Kashkari - Thursday
  • Barkin - Friday

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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