Fed, foreign central banks enhance liquidity measures, UBS acquires Credit Suisse

Topics

Treasury rally continues

• Volatility continued as Treasury yields dropped sharply across the curve for the second consecutive week.

Hedging activity remains elevated

• Hedging activity remains elevated as clients seek to manage their risk positions amid heightened interest rate volatility and macroeconomic uncertainty.

Fed, foreign central banks enhance liquidity measures, UBS acquires Credit Suisse in government-backed deal

• The Federal Reserve and five other central banks launched a coordinated effort to enhance global liquidity measures on Sunday, and UBS acquired Credit Suisse in a Swiss government-backed deal, after the Swiss lender showed serious signs of stress at the end of last week.

Treasury rally continues

• After seeing a sharp drop in yields the week prior, the Treasury rally continued in earnest last week, with the 2-year Treasury yield dropping 79 basis points to 3.81%, and the 10-year yield falling a more modest but still substantial 31 basis points to 3.39%.
  • The outsized moves in the short end saw the 2s/10s basis expand to its widest level since late October at -0.42%, steepening nearly 50 basis points on the week.
• Fed policymakers are scheduled to meet Tuesday and Wednesday of this week, but expectations for policy rate changes at this meeting have become increasingly unclear over the last two weeks in the wake of evolving banking industry stress.
  • As of Friday’s close, market participants see slightly better odds of a 25 basis point hike versus no hike, starkly contrasting the 50bp hike expectation from earlier this month.
  • The fallout from two U.S. bank failures and the unveiling of Fed-sponsored liquidity programs has resulted in a material shift in investor expectations for the policy rate in both the near-term and into 2024.
    • Investors now see the Federal Reserve easing financial conditions far sooner than expected at the beginning of the month, with the first rate cut expected in mid-summer 2023 compared to Q1 2024 at the start of the month.
• All eyes now turn to the Fed’s policy rate decision on Wednesday and the market’s reaction.

Hedging activity remains elevated

• Hedging activity remains elevated as clients seek to manage their risk positions amid heightened interest rate volatility and macroeconomic uncertainty.
• Liability-sensitive institutions are increasingly implementing strategies like the Portfolio Layer Method to protect against rising interest rates, given the increased flexibility from changes to the hedge accounting standard.
  • Although wholesale borrowing hedging activity has increased in recent months, we have seen more clients accomplish the same economic objective by leveraging fixed-rate assets in the hedge accounting relationship, bypassing the need to commit to wholesale borrowings for the life of the hedge.
• Asset-sensitive institutions continue to explore falling rate protection strategies, although activity in these hedging strategies moderated last week amid the substantial decline in rates.
• On the loan-level hedging side, a roller-coaster week saw borrowers in back-to-back programs rush to close loans and execute their hedges at the lowest rates since early February.
  • With rates in freefall, swap pricing for many banks has become increasingly cheap relative to conventional fixed-rate pricing, leading some banks and borrowers to shift course and move forward with floating-rate loans and swaps in lieu of conventional fixed-rate loans.

Fed, foreign central banks enhance liquidity measures, UBS acquires Credit Suisse in government-backed deal

• On Sunday, the Federal Reserve and five other central banks launched a coordinated effort to enhance global liquidity measures.
  • According to Sunday’s release, the six central banks agreed to increase the frequency of 7-day maturity U.S. dollar operations to daily from weekly in an attempt “to enhance the provision of liquidity” and “to improve the swap lines’ effectiveness in providing U.S. dollar funding.”
    • The move comes as recent liquidity stress at several large U.S. and European financial institutions heightened fears of a global banking crisis.
    • Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen were quick to downplay concerns of a growing crisis, emphasizing that the U.S. banking system remains “strong” and “resilient” in a joint statement released Sunday afternoon.
• Credit Suisse notched its worst weekly decline since the pandemic last week after liquidity fears reignited following U.S. financial system stress and comments from the bank’s top shareholder, prompting the Swiss government to publicly back the embattled lender with a loan of up to $54 billion and ultimately back an acquisition with fellow Swiss lender, UBS.
  • Credit Suisse’s position and global sentiment deteriorated over the weekend resulting in UBS agreeing to pay more than $2 billion for Credit Suisse in a Swiss government-backed deal aimed at restoring stability to the financial markets and the European banking industry.
    • UBS’ purchase price values Credit Suisse at a fraction of its implied value on Friday, resulting in considerable shareholder losses.
  • Reports suggest that there has been limited interaction between the two parties, with the Swiss National Bank brokering the majority of the deal.
  • As part of the acquisition, the Swiss National Bank announced it would offer a $100 billion credit line to UBS to enhance liquidity and improve stability in the combined entity.

The look forward

Upcoming economic data releases

• Existing Home Sales – Tuesday
• MBA Mortgage Applications – Wednesday
• Initial Jobless Claims – Thursday
• New Home Sales – Thursday
• Durable Goods Orders – Friday
• S&P Global Manufacturing / Services PMIs – Friday

Upcoming Federal Reserve Speakers

• FOMC Rate Decision – Wednesday
• Fed Chair Powell Post-FOMC Press Conference – Wednesday

Rates snapshot

Market implied policy path (overnight indexed swap rates)