Inflation moderates, large banks release earnings

Topics

FOMC Minutes suggest hiking cycle nears end

• After pulling back the week prior, Treasury yields moved higher across the curve as Fed officials reiterated their commitment to combatting inflation and recently released March inflation data suggested relaxing but still firm price pressures.

Banks hedge for higher rates so far in Q2

• After seeing a significant pick up in rising rate hedges in late Q1 due to increased wholesale funding needs and falling interest rates, rising rate hedging activity has continued to garner the lion’s share of hedging activity in Q2.

Large U.S. banks report Q1 earnings

• First quarter earnings season unofficially began on Friday, with several large U.S. financial institutions reporting earnings.

Inflation moderates, retail sales fall

• Investors reacted to two high-profile inflation releases and the latest retail sales figures

FOMC Minutes suggest hiking cycle nears end

• After pulling back the week prior, Treasury yields moved higher across the curve as Fed officials reiterated their commitment to combatting inflation and recently released March inflation data suggested relaxing but still firm price pressures.
  • The curve steepened modestly, with the 2-year Treasury yield increasing 11 basis points and the 10-year yield rising 13 basis points to 4.08% and 3.52%, respectively.
  • Although rates have oscillated in a wide range since the unveiling of the Fed’s Bank Term Funding Program in mid-March, the 2-year and 10-year yields are currently within five basis points of the levels seen the Monday following two high-profile bank closures and the launch of the emergency Fed lending facility.
• Despite inflation remaining at historically elevated levels, several Fed officials “emphasized the need to retain flexibility and optionality in determining the appropriate stance of monetary policy,” after banking industry stress prompted many officials to “lower their assessments of the federal funds rate target range that would be sufficiently restrictive,” according to the latest FOMC meeting minutes.
  • The latest minutes reiterated recent Fed officials’ forecasts for economy-wide credit tightening.
  • After the minutes’ release, many analysts commented that the Fed would likely continue on the outlined policy path in the Summary of Economic Projections, raising rates by 25 basis points one last time before pausing and evaluating the state of the labor market and the inflationary environment.
• At the close on Friday, market participants saw a roughly 80% probability of the FOMC raising the policy rate by 25 basis points in early May to a range of 5.00% - 5.25%.
  • Although Federal Reserve officials have downplayed the possibility of rate cuts this year in their commentary and economic forecasts, current market pricing forecasts the FOMC cutting campaign to begin in September 2023 and expects the FOMC to cut rates between two to three times before the end of the year.

Banks hedge for higher rates so far in Q2

• After seeing a significant pick up in rising rate hedges in late Q1 due to increased wholesale funding needs and falling interest rates, rising rate hedging activity has continued to garner the lion’s share of hedging activity in Q2.
  • Roughly 70% of hedges executed year-to-date across our balance sheet strategies desk are structured to protect against further increases in interest rates.
  • While many clients have expressed a need for wholesale borrowings, which are often suitable for a highly effective hedging relationship, approximately 60% of rising rate hedges have utilized the new flexibility afforded by the Portfolio Layer Method to hedge fixed rate assets rather than borrowings, accomplishing a similar economic objective but offering more flexibility in the accounting relationship.
• Hedges aimed to protect against a falling interest rate environment slowed in the wake of last month’s industry stress, but the recent increase in interest rates prompted many of our asset-sensitive clients to explore hedging alternatives, particularly out-of-the-money interest rate floors.
• Hedging activity has also increased for many clients’ borrower swap programs this month.
  • Despite another uptick in swap rates last week, banks continue to price conventional fixed-rate loans at rates substantially higher than borrowers can obtain via a floating-rate loan and swap.
    • With market rates having settled somewhat following the rapid decline last month, borrowers with existing floating rate debt have been increasingly willing to hedge now and recognize immediate interest savings rather than continue to pay a floating rate and wait for another possible dip before hedging.

Large U.S. banks report Q1 earnings

• First quarter earnings season unofficially began on Friday, with several large U.S. financial institutions reporting earnings.
  • Reports to date have been mostly viewed favorably by analysts as investors inspect 10-Qs and earnings call transcripts for details on the impact of last month’s banking sector stress.
• JPMorgan increased its net interest income guidance for 2023, arguing that a quicker-than-expected end to the Fed’s historic tightening cycle will ease deposit pressures and improve margin.
  • Interestingly, JPMorgan CFO Jeremy Barnum indicated that approximately $50 billion of the deposit inflows received because of two bank closures in mid-March remained on the balance sheet at the end of the quarter.
  • Due to the sector stress, Barnum suggested that the bank expects “a little bit of [credit] tightening” but that the bank intends to “underwrite through the cycle.”
• Market participants are gearing up for a busy week, with many U.S. financial institutions set to report in the coming days.

Inflation moderates, retail sales fall

• Consumer prices rose 0.1% in March, below the consensus estimate and last month’s 0.4% reading, according to the latest Consumer Price Index report.
  • Core inflation, which excludes the often-volatile food and energy components, rose by a more robust 0.4% pace in March.
  • The report reinforced recent inflation readings that suggested slowing but persistently elevated inflation.
• Producer prices saw a more significant pullback in March, falling 0.5% over the month on the back of declining gas prices.
  • The monthly decline in the core Producer Price Index marks the first deflationary reading since April 2020 at the onset of the pandemic.
  • Although recent inflationary readings have suggested easing price pressures, market participants continue to expect the Federal Reserve to raise interest rates by 25 basis points at the next FOMC meeting.
• Retail sales fell for the second consecutive month, declining 1.0% in March, as lower gas prices and fewer automobile sales led the drop.
  • Excluding gas and automobiles, retail sales fell a more modest 0.3% over the month, the first recorded drop since November and only the second monthly drop since the start of 2022.

The look forward

Upcoming economic data releases

• Empire Manufacturing Index – Monday
• Housing Starts – Tuesday
• Building Permits – Tuesday
• MBA Mortgage Applications – Wednesday
• Jobless Claims – Thursday
• Philadelphia Fed Business Outlook Survey – Thursday
• Existing Home Sales – Thursday
• Leading Index – Thursday
• S&P Global U.S. Manufacturing / Services PMIs – Friday

Upcoming Federal Reserve Speakers

• Barkin – Monday
• Bowman – Tuesday
• Goolsbee, Williams – Wednesday
• Waller, Mester, Bowman, Bostic, Harker – Thursday
• Cook – Friday

Rates snapshot

Market implied policy path (overnight indexed swap rates)