Hawkish FOMC meeting sends yields higher
- September 27, 2021
Balance Sheet Risk Management
Financial Institutions | Kennett Square, PA
Prior week summary
In yet another eventful week, the major U.S. equity indices ended flat to modestly higher while Treasury yields saw significant increases on the back of strong economic data and a hawkish FOMC meeting. The week started on a very volatile note with the S&P 500 falling below its 100-day moving average for the first time in nearly a year as investors reacted to the potential “spillover effect” from the impending default of Evergrande, the second-largest property developer in China. While the company failed to make an $83.5 million interest payment to bondholders on Thursday, market participant’s fears of broader credit implications for global markets diminished over the course of the week and the U.S. equity indices resumed their climb to finish the week in the green. Economic data releases were in plentiful supply last week with housing-related data dominating the headlines. Kicking off the week, housing starts picked up in August, topping both the consensus estimate and the July reading, as multifamily projects led the charge in the face of considerable construction backlogs. Meanwhile, building permits accelerated at a 1.73 million annualized pace in August, far exceeding analyst calls for a 1.6 million annualized pace. Existing home sales pulled back somewhat in August, however, as historically elevated home prices limited demand. The report indicated that just 29% of sales comprised of first-time home buyers, the lowest level since 2019. Finally, new home sales rose more than forecast to a four-month high, suggesting demand is stabilizing while developers gradually eat away at construction backlogs.
Although Evergrande’s credit issues and the week’s economic data garnered some attention during the week, the latest FOMC monetary policy meeting, held on Tuesday and Wednesday, captivated investors’ attention as market participants were eager to gain insight into the current thinking of Federal Reserve officials and what it could mean for the tapering timeline. As expected, the FOMC left both the target range and the current pace of monthly asset purchases unchanged but offered additional commentary on the asset purchase reduction timeline. Fed Chair Jerome Powell struck a decidedly more hawkish tone at last week’s FOMC meeting than during the speech he delivered at the Jackson Hole Economic Symposium in August. According to the statement released with the FOMC’s decision, “If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted.” Many analysts have forecasted that the November FOMC meeting is the likely venue for the tapering announcement. Federal Reserve Bank of Cleveland President Loretta Mester seemingly agreed with this line of thinking on Friday when she expressed support for, “starting to dial back our purchases in November and concluding them over the first half of next year.” While Fed Chair Powell has emphasized that the coming reduction to asset purchases does not forecast a timeline for eventual fed rate hikes, Mester indicated she expects, “that conditions for liftoff of the fed funds rate will be met by the end of next year.”
Although no major policy positions changed at the latest meeting, the hawkish comments from Fed Chair Powell sent mid and long-term Treasury yields soaring to end the week with the 10-year Treasury yield finishing the week at 1.47%, a ten-basis point jump from the week prior. While short-term Treasury yields also saw significant increases last week, the curve is decidedly steeper week-over-week. To put these steepening moves in context for our asset-sensitive clients in bank treasury, the compensation for extending the duration of floating rate loans with a five-year receive-fixed swap has increased nearly 15 basis points on a week-over-week basis. However, for liability sensitive banks who have been using forward-starting pay-fixed swaps to manage the price sensitivity of their investments, the premium of the forward coupon, relative to the current coupon, has remained roughly unchanged. For example, on a week-over-week basis, the relative forward premium associated with a forward starting seven-year swap starting one to two years forward increased less than one basis point, 17 basis points and 36 basis points, respectively.
The look forward
Market participants are gearing up for a very busy week of economic data releases with updated figures on durable goods orders, wholesale inventories, the Conference Board Consumer Confidence Index, the second estimate of second-quarter GDP, the PCE Deflator, construction spending, and the ISM Manufacturing Index, among others, dotting the economic calendar. Several Federal Reserve officials hold speaking engagements over the week. Fed Chair Jerome Powell and Treasury Secretary Janet Yellen appear before Congress on Tuesday and Thursday.
Market implied policy path (Overnight indexed swap rates)
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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.21-0256
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