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Market Update

Hawkish Fed sends rates higher

Date:
March 21, 2022
  • william smith headshot

    Authors

    Bill Smith

    Associate Director
    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA

Summary

Treasuries continued to sell-off last week, flattening the curve further, as the March FOMC meeting took center stage in a week packed with economic updates, geopolitical uncertainty, and a more-hawkish-than-expected Federal Reserve. While all tenors saw yield increases, the moves were most pronounced at the front-end of the curve with the two-year Treasury rising 22 basis points to 1.97%, the highest level since May 2019.

Interest rates

  • The Treasury sell-off continued in earnest last week as Treasury yields moved notably higher.
    • The weeks-long flattening of the Treasury yield curve continued with the oft-watched 2s/10s basis, falling just over three basis points to approximately 21 basis points.
      • The three-year Treasury yield and the 10-year Treasury yield inverted during the week with the three-year Treasury ending the week at 2.15% and the 10-year Treasury yield finishing the week at 2.14%, both levels substantially higher than where they began the week.
    • Notably, last week’s pickup in rates was largely due to market participants pricing in a more aggressive Federal Reserve rather than increasing inflation expectations.
      • The Fed-watched five-year forward, five-year breakeven inflation rate gave up roughly half of the week prior’s move higher, falling approximately 10 basis points to 2.36%.
    • Looking at the Fed Funds futures market, market participants are pricing in just under seven more quarter-point hikes by the end of 2022, implying a 50-basis point hike at one of the remaining six Federal Reserve meetings.
      • Currently, market participants are pricing in roughly a 50% chance of a 50-basis point hike at the FOMC’s next meeting in early May.

      Trading commentary

      • The significant volatility experienced in rates markets of late has continued to drive elevated hedging activity across our balance sheet desk.
      • Last week, we saw several clients unwind pay-fixed swaps that were hedging AFS securities in the investment portfolio, taking gains that have grown significantly since the turn of the year with the significant run-up in interest rates across the curve during that timeframe.
      • Additionally, we continue to see a substantial level of both inquiries and executions from clients looking to monetize the relative steepness of the curve and smooth earnings in a rising rate environment.
      • On our back-to-back trading desk, we continue to see significant hedging activity from real estate borrowers looking to lock in long-term fixed-rate financing given the expectation for many Federal Reserve rate hikes in the coming years along with the decades-high inflationary environment.
        • As we have mentioned previously, we are seeing a growing number of dealers widening out on LIBOR-based transactions as LIBOR trading activity dwindles and SOFR trading activity increases.

          Credit Union/Bank mergers gain steam to start 2022

          • M&A activity in the financial institutions space has started the year at a quick pace with Toronto-Dominion Bank’s planned acquisition of First Horizon marking the largest announcement of the year and attracting significant attention from market participants.
          • Credit unions have been quietly announcing deals to start the year as well, with five credit union/bank mergers announced in only the last three weeks.
            • To date, Summit Credit Union's planned acquisition of Commerce State Bank marks the largest deal announcement between a credit union and a bank with the combined institution holding approximately $5.7 billion in total assets.
          • 2021 marked a breakout year for credit union/bank mergers with deal count totaling 13 deals and target institution assets clocking in at roughly $6 billion.
            • 2022 is shaping up to be a strong year as well, with five deal announcements to date and target assets exceeding $2.5 billion.

            Hawkish Fed sends rates higher

            • In a widely expected move, the FOMC kicked off what is expected to be the start of an aggressive tightening cycle, raising the Federal Funds target range from near zero to 0.25% - 0.50%.
            • While the quarter-point hike was expected, meaningful updates to the FOMC’s Summary of Economic Projections turned the heads of many market participants and dominated headlines from the financial media.
              • Besides expecting slower GDP growth and higher inflation for 2022 than in December, the median expectation for 2022 rate hikes changed from three quarter-point hikes in December to seven quarter-point hikes in the latest release, implying a 25-basis point hike at each of the remaining six FOMC meetings for the year.
            • Finally, the FOMC held back from launching the start of the balance sheet reduction initiative but indicated that the process is expected to begin soon at “a coming meeting.”

                              The look forward

                              Upcoming economic data releases

                              • Chicago Fed National Activity Index – Monday
                              • Richmond Fed Manufacturing Index – Tuesday
                              • New Home Sales – Wednesday
                              • Jobless Claims – Thursday
                              • Durable Goods Orders – Thursday
                              • University of Michigan Consumer Sentiment Index – Friday

                                                      Upcoming Federal Reserve Speakers

                                                      • Bostic, Powell – Monday
                                                      • Williams, Daly, Mester – Tuesday
                                                      • Powell, Daly, Bullard – Wednesday
                                                      • Kashkari, Waller, Evans, Bostic – Thursday
                                                      • Daly, Waller, Williams, Barkin – 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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