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Market Update

Default averted; jobs defy expectations

June 5, 2023
  • Emmanuel Herrera headshot


    Manny Herrera

    Treasury Advisory

    Corporates | Kennett Square, PA


With Congress averting a default and jobs rallying, the FOMC will look to next week’s CPI report to see if a “hawkish pause” will prompt disinflation.

Default averted

The stalemate between the legislative and executive branches reached its long-awaited conclusion. Members of Congress passed legislation last Friday that was signed by President Biden, which averted a government default. According to the Treasury Department and the Congressional Research Service, Secretary Yellen’s “extraordinary measures” moved approximately $456 billion from various agencies and investments to the treasury’s general fund. Notably, the cash balance at the Treasury fell to just $22.892 billion last Thursday, so the debt deals appear to have come just in time. The 2-year yield hit 4.551% while the 10-year hit 3.743% over the news that Treasury may need to raise as much as a trillion dollars over the next three months in order to replenish those measures and continue to fund the government. This led credit rating agency Fitch to announce on Friday that the U.S.’s “AAA” rating would remain on the negative watch until the end of September 2023.

Resilient jobs keep Hawks vigilant

On Friday, the Bureau of Labor Statistics announced that the U.S. economy added 339,000 jobs in May, shattering analyst expectations of 190,000. Healthcare and Business services led the rally, with individuals who identify as self-employed suffering the largest setback. March and April figures were also revised up to 217,000 and 294,000, respectively. The Economic Situation Summary followed Wednesday’s Job Openings and Labor Turnover report that showed that job openings increased in May to 10.1 million. This comes as unwelcome news for the Federal Reserve and Chair Jerome Powell, who had hoped that the 10 consecutive rate hikes that the Federal Open Market Committee enacted were at last penetrating the broader economy.

April’s inflation report of 4.9% was the lowest level since April 2021 but still above the Fed’s 2% target. Some more dovish members of the FOMC cautioned away from reactionary measures in next week’s meeting. Philadelphia Federal Reserve President Patrick Harker, who is a voting member of the FOMC, said that the disappointingly slow disinflation would warrant a pause in rate hikes for one meeting. The May increase of the Federal Funds rate to 500-525 basis points was seen as a possible terminal rate by many market participants. President Harker insisted that inflation would fall to 3.5% this year and reach the Fed's 2% goal by 2025. Most analysts and the market partially align with President Harker and believe the broader FOMC will adopt what is being called a “Hawkish pause” during June’s FOMC meeting; that is hold rates with the possibility of increasing down the line.

In the interim, all eyes turn to next week’s Consumer Price Index (CPI) report. The Federal Reserve Bank of Cleveland’s Nowcast is anticipating May inflation to fall to 4.1% year-over-year, a sharp decline from April’s 4.9%. On a monthly basis that would represent a rise of 0.2%, down from the prior month’s 0.4%. Should inflation align with expectations, it could signal that June’s anticipated skip will be more of a hold. This outcome would be best for corporates seeking to hedge before the June 30 cessation of LIBOR. However, if inflation surpasses expectations, it could prompt the more hawkish members of the FOMC to push through another rate hike, which would almost certainly increase the cost of hedging.

(Related insight: Read, "Interest rate caps vs. swaps: weighing the alternatives")

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