Hawks begin circling the Fed
- June 21, 2021
Corporates | Kennett Square, PA
The Fed holds short-term rates steady but indicates rate hikes in 2023. The Fed’s inflation expectation revised upward to 3.4%. Equities fall, dollar strengthens, and 10-year Treasury rates are mixed. The U.S. economic recovery continues.
Economic conditions are continuing to improve within the United States, with 65% of adults fully vaccinated. As the economy creeps towards normalization, the Fed began indicating to markets that tapering and rate hikes are on the horizon. In standard Fed fashion, no definitive dates were provided, but the dot plot indicated rates are expected to increase by late 2023. The Fed will continue to tolerate higher inflation and increased their headline inflation expectation to 3.4%. Interestingly, when asked about the inflation timeframe the Fed uses to target average inflation, Powell responded by saying there was no definitive look-back period. In other words, the market does not know and cannot estimate how much inflation the Fed will tolerate before increasing rates. The Fed continues to maintain that inflation is transitory and expects it to subside in the short term. For now, the Fed will keep the target federal funds rate between 0 and 0.25% in an effort to achieve maximum employment and average inflation of 2% over the long run.
The market's reaction
Despite Powell stating, “The dots are not a great forecaster of future rate moves,” the market reacted strongly to a potential rate hike in late 2023.
With lackluster retail sales, housing starts, and initial jobless claims this week, equities seemed primed to drop on any news of more restrictive monetary policy. The Dow Jones Industrial Average had its worst week since October 2020 and dropped 3.45%. Meanwhile, the S&P 500 closed the week down 1.91% and the NASDAQ Composite closed the week down 0.28%.
U.S. dollar index
With the dot plot indicating the Fed will raise short-term rates in 2023, which is faster than anticipated, the dollar strengthened. Since interest rates are expected to move higher, dollar demand grew as foreign investors chased potentially higher U.S. interest rates.
U.S. 10-year Treasury
Treasury yields initially spiked on the Fed’s news of higher anticipated rates. However, as investors digested the Fed’s meeting, they seemed to agree that the Fed was taking inflation more seriously and lowered their inflation expectations. When inflation expectations fall, real yields improve and investors pay more for treasuries. As investors moved to buy treasuries on lower real yield assumptions, they increased treasury prices and decreased yields. The 10-year treasury yield closed lower for the week at 1.44%.
Gold futures hit their lowest levels since April because of the Fed’s commentary. Gold is commonly viewed as a hedge against inflation. Therefore, investors sold gold when they began to collectively agree the Fed was taking inflation more seriously.
Lumber futures also fell dramatically this week with prices down 47.87% from their May highs. DIY projects and construction has slowed as consumers shift their focus from home improvement to vacations and other activities previously unavailable during the pandemic.
Takeaways for corporations
If corporations have FX exposure or are anticipating debt issuance, they need to keep an eye on both tapering and inflation.
Long-term rates are currently being held down by quantitative easing and a continued message of sustained low rates from the Fed. When tapering begins, long-term rates and the LIBOR/SOFR curves will be expected to drift upward. If inflation continues to persist at above average levels, the Fed may act to increase rates ahead of their 2023 forecast.
(Related insight:, Read, "Managing interest rate risk on future debt issuances")
From a historical perspective, when the Fed tapered bond buying back in 2013, emerging markets became extremely volatile. This is something to keep in mind when tapering begins again. FX will also be impacted if the Fed increases rates ahead of 2023 due to inflation. Should this occur, the dollar will be expected to strengthen.
(Related insight: Watch or read, "Operational FX hedging programs and the one leading practice you can't afford to ignore")
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.21-0177
Our featured insights
Persistent inflation weighs on the market as energy prices continue to rise
Treasury yields lost recent gains last week despite continuing inflation as consumer prices rose 5.4% year-over-year. Energy prices continue to rise amidst high demand and supply constraints.
Non-core inflation strikes again
Despite many central banks’ transitory inflation perspectives, inflation returned this week as commodity and food prices continued to rise. The five-year breakeven inflation rate, a broad measure of the market’s long-term inflation expectation, hit its highest reading since May after rising 13...
Yields climb on Fed tapering bets
FOMC aftermath and fiscal policy wrangling combined to drive 10-year yields to their highest levels in three months, peaking at 1.55% this week, impacting borrowers and hedgers alike. Meanwhile, price pressures in the energy sector continued their upward march.
Treasury yields climb as Fed holds rates steady
The Fed holds short-term rates steady but indicates at least one rate hike in 2022 as U.S. economic recovery continues.
Inflation plateaus as commodities continue upward climb
August CPI data showed inflation declining slightly from its June 2021 peak, while in energy markets recent supply shocks continue to drive prices higher. Interest rates remain range bound as next week’s FOMC meeting approaches.
FX and commodities volatility continue despite continued reopenings
As global economies struggle with natural disasters and the surging COVID-19 delta variant, economic indicators are painting mixed stories about recovery. U.S. initial jobless claims hit a pandemic low, while the dollar’s strengthening trend may be wavering in response to a more bullish stance...
August nonfarm payrolls highlight week of mixed data
As the market continued to react to Federal Reserve Chair Powell’s remarks at the Jackson Hole Economic Symposium, August nonfarm payrolls grabbed headlines after falling short of expectations. Elsewhere, data came in mixed as the delta variant continues to weigh on increased demand.
4 questions to ask when evaluating treasury technology platforms
Treasury teams increasingly rely on technology platforms to automate routine tasks, improve accuracy, and inform strategic decisions surrounding working capital, liquidity, and financial risk management. With an ever-growing ecosystem of technology platforms available to treasury and accounting...