FOMC hikes rates, yields drop

Treasury yields end lower in a volatile week of trading

• Despite the short-end of the curve dropping by the week’s end, yields saw notable swings, with the 2-year Treasury yield rising as high as 4.14% before ending the week at 3.92% and the 10-year yield climbing to 3.59% before finishing where it began the week at 3.44%.

Hedging activity picks up amid volatility

• Despite the industry and rate volatility experienced last week, hedging activity increased as clients looked to fine-tune their interest rate risk positions.

Regional bank stress continues in the wake of the second-largest collapse

• Regional bank shares experienced substantial volatility last week as investors grappled with the outlook following the failure of a major U.S. lender the week prior.

April NFP report impresses, manufacturing industry receives boost

• Investors received a plethora of economic updates last week, including the April non-farm payroll report and the national ISM Manufacturing Index release.

Treasury yields end lower in a volatile week of trading

• Despite the short-end of the curve dropping by the week’s end, yields saw notable swings, with the 2-year Treasury yield rising as high as 4.14% before ending the week at 3.92% and the 10-year yield climbing to 3.59% before finishing where it began the week at 3.44%.
• The front end’s drop saw the 2s/10s basis steepen by 12 basis points to -0.48%, still significantly inverted but notching the highest level since early April.
• The stress in the regional banking space, coupled with Jerome Powell’s comments after the FOMC meeting, drove the declines.
• The FOMC raised the target range by 25 basis points to 5.00% - 5.25% in a widely expected move.
• Although market participants expected the increase, Jerome Powell’s commentary after the meeting sent yields lower when he hinted at a pause in rate increases.
• During the press conference, Powell assured that the banking system remains sound and resilient but suggested that the volatility experienced in the banking space “appear to be resulting in even tighter credit conditions for households and businesses” and that “these tighter credit conditions are likely to weigh on economic activity, hiring and inflation.”
• Current Fed Funds futures project that Wednesday’s rate increase will be the final hike in a historic Fed tightening cycle.
• Unlike the Federal Reserve’s dot plot forecast, market participants expect the Fed to begin cutting rates in the fall of 2023 and to slash rates approximately 100bps by the end of January.

Hedging activity picks up amid volatility

• Despite the industry and rate volatility experienced last week, hedging activity increased as clients looked to fine-tune their interest rate risk positions.
• Although asset-sensitive clients have returned recently to explore and execute falling rate hedging strategies, liability-sensitive institutions hedging against further increases in interest rates drove the lion’s share of executions.
• The decline in yields recently has improved the attractiveness of these strategies for many clients, given the increase in the implied initial positive carry as overnight rates have risen and term rates have fallen.
• Wholesale borrowings and fixed-rate assets remain the most popular balance sheet items utilized for hedge accounting treatment, with fixed-rate assets taking a slight majority given the flexibility improvements offered by the Portfolio Layer Method.
• Due to continued banking sector stress last week, intermediate-term interest rates hit lows not seen in roughly eight months. Borrowers with existing floating-rate debt moved quickly to capitalize on this dip, a theme we’ve seen gain popularity in the last couple of months. Borrowers can now recognize well over 100 bps in immediate interest savings by utilizing an interest rate swap to hedge existing debt for tenors ranging from 3-10 years, with no cash outlay.

Regional bank stress continues in the wake of the second-largest collapse

• Regional bank shares experienced substantial volatility last week as investors grappled with the outlook following the failure of a major U.S. lender the week prior.
• While bank shares declined in aggregate last week, two west coast lenders felt the brunt of the market’s banking fears, experiencing significant drops in equity prices before rebounding somewhat by the weekend.
• The impromptu sale of a U.S. lender the week prior reignited the fears that started in March, mainly profitability concerns stemming from significant losses in banks’ investment portfolios, shrinking deposit bases, and commercial real estate sector exposure.
• Volatility has continued into this week, with regional banks’ shares starting the week in the green as we head to print on Monday.

April NFP report impresses, manufacturing industry receives boost

• Investors received a plethora of economic updates last week, including the April non-farm payroll report and the national ISM Manufacturing Index release.
• According to the Commerce Department, the U.S. economy added 253,000 jobs in April, well above the 185,000 consensus expectation and the downwardly-revised 165,000 jobs added in March.
• Wage pressures remained resilient in April, with average hourly earnings rising 0.5% over the month, the largest increase in nearly a year.
• Although the strong labor report increases the likelihood of future rate hikes, investors largely expect the Federal Reserve to have finished hiking interest rates for the foreseeable future and to pause for the next several months.
• After seeing signs of a contraction in the regional and national manufacturing surveys recently, the manufacturing industry received a boost last week as several high-profile reports pointed to improving conditions, albeit slowly.
• The national ISM Manufacturing notched its sixth month in contractionary territory but rebounded off the multi-year low reported in March due to modest improvements in orders and production.
• Elsewhere, the S&P US Manufacturing PMI remained in expansionary territory for the second consecutive month, and both construction spending and factory orders picked up monthly.

The look forward

• Upcoming economic data releases
  • Wholesale Inventories – Monday
  • Consumer Price Index – Wednesday
  • MBA Mortgage Applications – Wednesday
  • Jobless Claims – Thursday
  • Producer Price Index – Thursday
  • University of Michigan Sentiment - Friday
• Upcoming Federal Reserve Speakers
  • Kashkari – Monday
  • Jefferson, Williams – Tuesday
  • Waller – Thursday
  • Daly, Bullard - Friday

Rates snapshot

Market implied policy path (overnight indexed swap rates)