Equities shake off virus jitters; ARRC talks Term SOFR
- July 26, 2021
Balance Sheet Risk Management
Financial Institutions | Kennett Square, PA
Prior week summary
Despite a sharp selloff to start the week, the three major U.S. equity indices recovered to finish the week higher, each setting new all-time highs, as market participants focused on a strong start to the corporate earnings season and shrugged off mostly weaker-than-expected economic data and renewed fears of the COVID-19 delta variant. Fears of a global slowdown weakened investor sentiment early in the week as the continued spread of the delta variant increased the likelihood of a return of virus-related business restrictions, a major roadblock for a nascent global recovery. Cases of the COVID-19 delta variant have increased at an accelerated pace in recent weeks with cases rising 45% week over week in the heavily vaccinated U.K. In the U.S., the new, more transmissible variant has spread most rapidly in areas with lower vaccination rates and caused some counties, like Los Angeles County, to reinstate indoor mask mandates for all individuals. Speaking to reporters on Saturday, Director of the U.S. National Institute of Allergy and Infectious Diseases Anthony Fauci cautioned that the U.S. is heading in the “wrong direction” and warned that the delta variant, “has this extraordinary characteristic of being able to spread very efficiently and very easily from person-to-person.” The dip in sentiment precipitated a steep drop in long-term yields with the 10-year Treasury yield touching as low as 1.13% intraday on Tuesday, marking a roughly 18 basis point decline from Friday’s close. Long-term rates would recover over the latter half of the week, however, as the 10-year Treasury yield finished the week only one basis point lower than where it began at 1.30%.
Economic data releases have been top of mind in recent months as investors look for clues to help in discerning the breadth and magnitude of the U.S. recovery. Housing starts topped expectations on Tuesday increasing at a 1.64 million annualized pace in June, snapping a two-month stretch of declines. Building permits, a leading indicator to housing starts, fell sharply in June, highlighting the impacts of strained supply chains and historically high input costs. The existing home sales release for June rounded out the week’s housing-related data, falling modestly below the consensus estimate but notching the first increase in five months. The manufacturing industry continues to improve despite substantial supply-side issues. The IHS Markit flash manufacturing PMI increased to 63.1 in July, topping expectations and reporting the highest reading since the series began. Inflationary pressures remained near the forefront of the report with the prices paid component increasing to a series high of 86.4. Conversely, the service sector looks to be experiencing some headwinds as the IHS Markit services PMI fell far further than analyst estimates to 59.8. Lastly, jobless claims resumed their climb higher far exceeding the consensus estimate as 419,000 claims were reported for the week of July 17.
The Alternative Reference Rates Committee (ARRC) made headlines on Wednesday when the Federal-Reserve-convened group announced recommendations for “conventions and use cases” for “how best to employ the SOFR Term Rates to successfully transition away from U.S. dollar LIBOR.” Within the committee’s recommendation for new contract uses, the ARRC expressed their support, “for the use of the SOFR Term Rate in addition to other forms of SOFR for business loan activity.” While the ARRC indicated they do not support, “the use of the SOFR Term Rate for the vast majority of the derivatives markets, because these markets already reference SOFR compounded in arrears and transitioning derivatives markets to the more robust overnight risk-free rates is essential to ensure financial stability as emphasized by the Financial Stability Board,” the committee made an important distinction saying, “The ARRC recommends that any use of SOFR Term Rate derivatives be limited to end-user facing derivatives intended to hedge cash products that reference the SOFR Term Rate.” The committee is expected to formally endorse the CME Group’s Term SOFR Reference Rates in the coming days.
The look forward
Market participants are gearing up for a busy week of economic data releases to end the month with updated figures on new home sales, durable goods orders, the Conference Board Consumer Confidence Index, wholesale inventories, the advance estimate of Q2 GDP, jobless claims, and consumer spending, among others, dotting the economic calendar. The FOMC meets for the latest monetary policy meeting on Tuesday and Wednesday.
Market implied policy path (Overnight indexed swap rates)
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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.21-0202
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