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Fed minutes reiterate FOMC’s hawkish stance; June NFP surprises to the upside

July 11, 2022
  • william smith headshot


    Bill Smith

    Associate Director
    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA


Erasing the moves seen the week prior, Treasury yields continued to experience significant volatility, rising considerably across the curve, as market participants digested the latest economic data and the minutes from the June FOMC monetary policy meeting.

Interest rates

  • After dropping 25 basis points the week prior, the 10-year Treasury yield erased much of that decline, rising 21 basis points to end the week at 3.09%.
    • Despite the large pickup at the long end of the curve, the short end saw an even greater increase with the two-year Treasury yield climbing 28 basis points to 3.12% by the week’s end.
  • Compressing for several weeks, the 2s/10s basis turned negative last week, a recessionary signal, with the two-year yield now sitting approximately three basis points above the 10-year yield.
  • Market participants recalibrated their Federal Funds rate expectations last week after hearing from several Fed officials and digesting the latest FOMC monetary policy meeting minutes, both of which suggested that the FOMC would raise rates well above the neutral zone to combat a persistently high inflationary environment.
    • Digging into the Minutes, officials were worried that “elevated inflation could become entrenched if the public began to question the resolve of the committee,” and judged that it would be appropriate to raise the Target Range by either 50 or 75 basis points in July.
      • Current market pricing has a 75 basis point hike fully priced in for the July meeting with an additional 2% from current levels priced in by year-end.
    • Fed Governor Christopher Waller also expressed urgency in combating inflation last week saying that the committee needs to “move to a much more restrictive setting,” and must do that “as quickly as possible.”
  • Finally, real yields across the curve also pushed notably higher with the five-year real yield crossing 50 basis points to end the week at 0.51%.

    Trading commentary

    • Activity across our balance sheet risk management desk remained elevated last week as heightened rate volatility increased the desire for some institutions to hedge.
    • Plain vanilla interest rate swaps have been far and away the most popular derivative instrument used to manage interest rate risk in either direction, but our desk has seen a moderate rise in the use of option-based products since the start of the second quarter.
      • Recently, a liability-sensitive client capped the cost of wholesale funding at the FHLB with an out-of-the-money interest rate cap.
      • Separately, several clients have implemented zero-cost collar strategies, buying a floor to limit their risk to a downturn in rates while selling a cap to offset the value of the floor.
        • This strategy has proved quite popular as it allows institutions to receive income in a falling rate environment but also to enjoy the full benefit of the floating rate loan portfolio repricing higher so long as the index setting remains below the strike of the sold cap.

      Financial institutions' betas remain low despite quick pace Fed hikes

      • With the FOMC raising the Target Range rapidly since the turn of the year, some analysts suggested that deposit betas could behave materially different than the last cycle given the quick pace of the current tightening cycle.
      • To date, betas remain low according to an analysis conducted by S&P Capital IQ.
      • Due to continued excess liquidity and low loan-to-deposit ratios, betas on one-year certificates of deposit remain low across the industry despite rising modestly in recent weeks.
        • Looking at large institutions ranging from $50 - $250 billion in assets, the rates on a one-year CD have increased 39 basis points in the last year, equating to approximately a 26% beta.

        Economic data

        • After a weak slate of economic data releases the week prior, last week’s economic releases proved more encouraging, with many updates clocking in better than expected.
        • In an encouraging sign for the manufacturing industry, both factory and durable goods orders posted May levels meaningfully above the consensus estimate and their respective April readings.
          • Notably, new factory orders advanced considerably in May defying the regional manufacturing surveys that have suggested a contraction of new orders in recent weeks.
        • The ISM Services Index fell less than expected to 55.3, the lowest level seen in two years, as new orders decreased, and supply chain disruptions and labor shortages continued to serve as headwinds.
        • Finally, all eyes turned to the June non-farm payroll release on Friday which indicated that the U.S. economy added 372,000 jobs in June, slightly below the job gains seen in May but far above the consensus estimate.
          • Analysts speculated after the report that the above consensus employment reading would allow the FOMC to press ahead with plans for several rate hikes by the year’s end.
          • The unemployment rate held steady at 3.6%, just 0.1% above the 50-year low of 3.5% seen before the pandemic.

          The look forward

          Upcoming economic data releases

          • Consumer Price Index - Wednesday
          • Beige Book - Wednesday
          • Producer Price Index - Thursday
          • Jobless Claims - Thursday
          • Empire Manufacturing Index - Friday
          • Retail Sales - Friday
          • Industrial Production - Friday
          • University of Michigan Consumer Sentiment Index - Friday

            Upcoming Federal Reserve speakers

            • Williams - Monday
            • Barkin - Tuesday
            • Waller - Thursday
            • Bostic, Bullard - 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


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