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Market Update

FOMC hikes 75 basis points, signals more to come

Date:
September 26, 2022
  • william smith headshot

    Authors

    Bill Smith

    Associate Director
    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA

Summary

In a week dominated by the highly-anticipated September FOMC policy meeting, Treasury yields pushed significantly higher as investors recalibrated their bets for Fed policy action in the near term.

Interest rates

  • Treasury yields moved sharply higher, particularly at the policy-sensitive short-end of the curve, as the Fed maintained its inflation-fighting stance, raising the Target Range 75 basis points to a range from 3% - 3.25%.
  • The outsized moves at the front end flattened the curve further.
    • The 2s/10s basis, a popular measure of the Treasury curve’s steepness, compressed 11 basis points to end the week at -0.53%, the measure’s lowest level since April 2000.
  • Although price stability has been long-identified as the top priority for the current Fed, it was the update to the Summary of Economic Projections (SEP) that quantified the Fed’s commitment to bringing price increases back to more normalized levels and that materially altered market participants’ short-term rate expectations.
    • According to the updated SEP, Fed officials expect the policy rate to be 1.25% higher than current levels by year-end.
    • With only two FOMC meetings left in 2022, a fourth consecutive 75-basis point hike appears on the table at the next FOMC policy meeting in early November based on the Fed’s updated projections.
    • Looking at Fed Funds futures market pricing at the close on Friday, investors see an 80% chance of a 75 basis point hike at the next FOMC meeting, and see an additional 1.25% of rate increases by year-end, roughly matching the Fed’s median forecast published in the updated SEP.
  • Finally, inflation expectations remain relatively well-anchored.
    • Having fallen for several weeks, the Fed-preferred five-year forward, five-year breakeven inflation rate picked up slightly last week and currently stands at 2.27%, above the Fed’s 2% average target but well below the latest core PCE reading of 4.40%.

Trading commentary

  • Hedging activity remained elevated last week as clients debated executing on either side of the Fed policy decision on Wednesday.
  • Strategies designed to reduce asset sensitivity and prepare for a downturn in interest rates continue to be implemented more frequently than their rising-rate-protection strategy counterparts.
    • While floating rate loans have been the most often utilized balance sheet item to achieve hedge accounting for these strategies, we have seen clients look to the floating rate securities portfolio and the fixed-rate debt portfolio in recent weeks to accomplish similar economic and accounting objectives.
  • In the other direction, funding hedges remain popular across our client base as we hear from more clients about their recent needs for wholesale funding.
  • To date, the majority of clients using pay-fixed swaps to extend the duration of their liabilities and lock in the cost of wholesale funding have used short-term SOFR-based FHLB advances as the funding source resulting in a highly effective accounting relationship and a well-aligned hedging relationship.

Despite slowing loan growth, CRE loans see pick up

  • Although many big bank executives have commented that aggregate loan growth has slowed in the third quarter, many U.S. financial institutions are experiencing significant growth in commercial real estate (CRE) loans.
  • According to S&P Capital IQ, financial institutions exceeding regulatory guidelines for commercial real estate exposure increased for the fifth consecutive quarter.
    • 505 U.S. financial institutions exceeded regulatory CRE exposure guidelines in the second quarter, a robust 50.3% increase from a year earlier.
  • The increase in CRE loans comes at a time when many institutions are experiencing slowing loan growth in aggregate and are weary of the global economic outlook coming out of a period of loose financial conditions.

Economic data

  • Last week’s economic calendar was relatively light with the housing and manufacturing sectors in focus.
  • Housing-related data was mixed as both housing starts and existing home sales topped analysts’ expectations, but the forward-looking building permits release showed signs of weakness falling notably below both the consensus estimate and July’s reading.
    • Higher interest rates have driven demand for single-family homes near a two-year low, but multifamily construction soared 28% in August to its highest level since 1986.
  • Manufacturing-related releases painted a mixed picture.
    • The Kansas City Fed Manufacturing Activity Index defied calls for a gain and instead declined to a 1.0 level in September, barely remaining in expansionary territory.
      • Despite the month-over-month decline, both new orders and production showed notable improvements compared to levels seen in August.
    • The S&P Global Manufacturing PMI improved slightly in September but remains well-off levels seen a year ago.
  • Finally, jobless claims ticked up slightly to 213,000 for the week ended September 17.
    • Although claims rose slightly from the week prior, the current jobless claims level sits just above a four-month low and continues to suggest a healthy labor market.

The look forward

Upcoming economic data releases

  • Chicago Fed National Activity Index – Monday
  • Dallas Fed Manufacturing Activity Index – Monday
  • Durable Goods Orders – Tuesday
  • Conference Board Consumer Confidence Index – Tuesday
  • Richmond Fed Manufacturing Index – Tuesday
  • New Home Sales – Tuesday
  • Wholesale Inventories – Wednesday
  • Jobless Claims – Thursday
  • 2nd Quarter GDP (third estimate) – Thursday
  • Core PCE – Thursday
  • Personal Spending – Friday
  • University of Michigan Consumer Sentiment – Friday

Upcoming Federal Reserve Speakers

  • Collins, Bostic, Logan, Mester – Monday
  • Powell, Evans, Bullard, Kashkari, Daly – Tuesday
  • Powell, Bostic, Bullard, Bowman, Barkin, Evans – Wednesday
  • Bullard, Mester, Daly – Thursday
  • Barkin, Brainard, Bowman, Williams – 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


Disclaimers

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

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.

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