Long-end rises following solid economic data, FOMC minutes

Rates rise following solid economic data, FOMC minutes

• Treasury yields rose across the curve last week, but the long-end experienced the most significant pick-up.

Wholesale borrowing hedging activity increases

• Liability-sensitive clients mitigating their balance sheet exposure to further increases in interest rates dominated the hedging activity we saw last week.

Economic data remains solid on back of resilient consumer

• Despite difficulty in the manufacturing industry, many analysts and Federal Reserve officials have noted that economic activity has held up better than anticipated in the face of decades-high inflation and long-term interest rates.

Rates rise following solid economic data, FOMC minutes

• Treasury yields rose across the curve last week, but the long-end experienced the most significant pick-up.
• The two-year yield rose three basis points to end the week at 4.92%, while the 10-year yield increased a far more robust 10 basis points to end Friday at 4.26%.
• The more pronounced movement at the long-end saw the Treasury curve steepen, bringing the 2s/10s basis to -0.66% and in line with the yearly average.
• The Treasury curve has steepened notably in August, with the 2s/10s basis increasing 21 basis points this month.
• Investors gained additional insight into the last FOMC monetary policy meeting following Wednesday’s release of the late July meeting minutes.
• “Most” participants remained concerned about the upside risk to inflation but cautioned that the committee must “balance the risk of an inadvertent overtightening of policy against the cost of an insufficient tightening.”
• Notably, two officials “could have supported” a proposal to leave interest rates unchanged.
• The latest minutes highlighted the evolving divergence of opinions among officials as policymakers near the end of their forecasted hiking cycle and remain concerned about easing but still-elevated inflation.
• Despite the hawkish minutes, investors expect no additional hikes this year.
• Friday's Fed Funds futures pricing suggests investors see a roughly 35% chance of another hike in 2023 and expect a series of interest rate cuts to kick off in the second quarter of 2024.

Wholesale borrowing hedging activity increases

• Liability-sensitive clients mitigating their balance sheet exposure to further increases in interest rates dominated the hedging activity we have seen this year.
• Although wholesale borrowing hedging accounted for the majority of rising rate hedging historically, the flexibility improvements offered by hedging fixed-rate assets using the Portfolio Layer Method (PLM) garnered much of the hedging activity seen year-to-date.
• In August, however, wholesale borrowing hedging activity returned and outpaced the PLM transactions we have seen crossing our balance sheet strategies desk.
• While clients continue to execute similar tenor transactions in the two-three-year range on average, the need to fund a more significant portion of the balance sheet with wholesale funding than in recent years has driven those clients to hedge the borrowings directly, offering an easy path to hedge accounting treatment and a geographically similar offset to movements in the bond portfolio.
• On the flip side, clients exposed to a falling interest rate environment have looked to capitalize on the recent rise in rates and execute transactions that are economically more favorable than a few weeks ago.
• Interestingly, in recent weeks, most asset-sensitive institutions utilized option products, namely interest rate floors and costless collars, rather than swaps to manage their falling rate risk.

Economic data remains solid on back of resilient consumer

• Despite difficulty in the manufacturing industry, many analysts and Federal Reserve officials have noted that economic activity has held up better than anticipated in the face of decades-high inflation and long-term interest rates.
• Investors received more solid data last week after the release of updated figures on retail sales, manufacturing, and the housing sector.
• According to the Commerce Department, retail sales advanced 0.70% in July, far greater than the 0.30% increase in June and nearly double the consensus estimate.
• Consumers remain resilient, primarily supported by a strong labor market, with discretionary sectors like restaurants, bars, and clothing stores experiencing the largest monthly gains.
• The report reinforced the “higher-for-longer” narrative as investors grew more confident that the Fed can continue to hold a restrictive policy stance amid apparent consumer strength.
• Although the regional Empire Manufacturing Index fell notably below expectations, manufacturing activity indicators pointed to improving conditions.
• The regional Philadelphia Fed Business Outlook Survey defied calls for a negative reading and instead increased to its highest level since April 2022 and notched its first reading in expansionary territory since last summer.
• Measures of new orders and shipments increased substantially in August, but price pressures lingered as the “prices paid” measure clocked its highest reading since March.
• Updated figures on industrial production and capacity utilization also topped expectations.

The look forward

Upcoming economic data releases

• Existing Home Sales – Tuesday
• Richmond Fed Manufacturing Index – Tuesday
• MBA Mortgage Applications – Wednesday
• S&P Global US Manufacturing / Services PMIs – Wednesday
• New Home Sales – Wednesday
• Jobless Claims – Thursday
• Chicago Fed National Activity Index – Thursday
• Durable Goods Orders – Thursday
• University of Michigan Consumer Sentiment – Friday

Upcoming Federal Reserve Speakers

• Barkin, Goolsbee – Tuesday
• Harker – Thursday
• Powell, Harker – Friday

Rates snapshot

Market implied policy path (overnight indexed swap rates)