FOMC Dots turn heads
- June 21, 2021
Balance Sheet Risk Management
Financial Institutions | Kennett Square, PA
Prior week summary
The major U.S. equity indices ended the week lower as weaker-than-expected economic data and a more hawkish-than-expected FOMC monetary policy meeting dominated headlines and dampened investor sentiment. All eyes turned mid-week to Fed Chair Jerome Powell and the FOMC as investors awaited any forecasted changes to monetary policy. As expected, the FOMC left the target range unchanged at 0.00%–0.25% and indicated that the current $120 billion per month pace of asset purchases would continue. The Committee made two technical adjustments, raising the reverse repo rate from 0.0% to 0.05% and increasing the interest on excess reserves rate from 0.10% to 0.15%. Unexpectedly, the FOMC appeared more hawkish during this meeting than in the March meeting. In particular, the FOMC’s Summary of Economic Projections release received much attention from analysts and market participants at the conclusion of Wednesday’s meeting. Most notably, the Summary of Economic Projections now shows the median forecast for the Federal Funds rate at the end of 2023 at 0.60% up from 0.10% in March. According to the updated dot plot, the FOMC median projection now calls for two rate hikes in 2023, an acceleration from the previously forecasted timeline that saw the policy rate unchanged through 2023. Additionally, the FOMC’s median projection for 2021 real GDP growth and inflation moved higher from March to 7.0% and 3.4% respectively. In the press conference following the FOMC’s decision, Fed Chair Powell looked to downplay the forecasted rate timeline cautioning that the dot plot “needs to be taken with a grain of salt,” and that it is, “not a great forecaster of future rate moves.” Nonetheless, treasury yields spiked across the curve on Wednesday with the five-year Treasury yield moving as high as 0.91%. Notably, the increase in short- and mid-term Treasury yields persisted for the remainder of the week with the three-year Treasury yield finishing the week approximately 16 basis points higher at 0.47% and the five-year Treasury yield finishing the week 13 basis points higher at 0.89%. While the 10-year Treasury yield experienced a pop in the initial aftermath of the FOMC policy meeting, the 10-year yield finished the week roughly two basis points lower at 1.45%.
Market participants received several high-profile economic updates last week that largely fell short of expectations. Retail sales fell 1.3% in May, below the expectation for a 0.8% decline. The latest release highlighted an ongoing shift in consumer preferences from stay-at-home goods to services as COVID-19 case counts decline across the country and the economy reopens. The Empire Manufacturing Index fell to 17.4 in June, down from the 24.3 level seen in May, as supply-side woes continue to limit the impact of strong consumer demand. Tuesday’s release of the Producer Price Index (PPI) indicated that wholesale prices increased 0.8% in May, above the 0.5% consensus expectation. Notably, the core PPI reading, which excludes the often-volatile food and energy components, also topped expectations with prices rising 0.7% month over month. After seeing six consecutive weeks of declines, jobless claims increased week over week to 412,000 claims for the week of June 12. Continuing claims also moved higher clocking in at 3.518 million claims.
Earlier this month, the Financial Stability Oversight Council, chaired by U.S. Treasury Secretary and former Fed Chair Janet Yellen, met to discuss the current state of the LIBOR transition. Secretary Yellen expressed support for SOFR noting that it, “provides a robust rate, suitable for use in most products and with underlying transaction volumes that are unmatched by other LIBOR alternatives.” While credit-sensitive alternatives to LIBOR, like AMERIBOR and BSBY, have gained steam in recent months, Yellen appeared to caution against some of these alternatives saying, “The decisions made now around the selection of alternative rates will determine whether some of LIBOR’s shortcomings may be replicated through the use of alternative rates that lack sufficient underlying transaction volumes. I am concerned about recent use, and potential future growth in use, of these rates in derivatives, where the volume of derivatives contracts referencing these alternative rates could quickly outnumber the transaction volumes underlying the reference rate, leaving it vulnerable to manipulation and disruption — one of the primary issues with LIBOR”, and noted that, “A failure to adopt robust alternative rates would leave us continuing to face the same risks and challenges that we face today.”
The look forward
Market participants are gearing up for a busy week of economic data releases with updated figures on new and existing home sales, the Markit Manufacturing and Services PMIs, wholesale inventories, durable goods orders, and the third estimate for first-quarter GDP, among others, dotting the economic calendar.
Market implied policy path (Overnight indexed swap rates)
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