Long end rises sharply, employment reports diverge

Long end rises sharply after employment reports

• Treasury yields increased across the curve last week, but the long end saw the most pronounced moves.

Asset-sensitive clients increase hedging activity

• Asset-sensitive clients hedging against a falling rate environment have returned in numbers recently as rates have risen and the economics of downrate protection strategies have improved significantly.

Employment reports diverge, manufacturing data disappoints

• Last week’s June non-farm payroll release garnered significant investor attention, along with the ADP employment report and several manufacturing-related releases.

Long end rises sharply after employment reports

• Treasury yields increased across the curve last week, but the long end saw the most pronounced moves.
• The 2-year rose seven basis points to 4.94%, while the 10-year rose a far more significant 25 basis points to end the week at 4.06%.
• After nearing a multi-decade low intraday on Thursday following the release of the ADP employment report, the 2s/10s basis rose considerably to end the week at -0.88%.
• Although last week's employment reports drove significant volatility, investors also had plenty of Fed speak and the latest FOMC minutes to grapple with.
• According to the latest dot plot and confirmed by the Minutes, "almost all" officials expect to continue raising rates through 2023 to combat stubbornly high inflation.
• Interestingly, the Minutes alluded to diverging opinions at the latest meeting, with "some" officials preferring a 25 basis point hike but deeming a pause "acceptable."
• The latest Fed Funds futures pricing suggests market participants are now more closely aligning their expectations for the policy rate to the Fed, but a divergence remains.
• Looking at the latest pricing, investors expect a 25 basis point hike at the July FOMC meeting and see a strong possibility of a second hike later in the year before the Fed kicks off an easing campaign in 2024.

Asset-sensitive clients increase hedging activity

• Hedging activity has picked up steam as we closed the first week of the third quarter.
• Asset-sensitive clients hedging against a falling rate environment have returned in numbers recently as rates have risen and the economics of downrate protection strategies have improved significantly.
• Option-based strategies have been preferred by those hedging against falling rates, with interest rate floors and collars comprising most of the asset sensitivity hedging recently.
• Floating-rate loan portfolios have been utilized most heavily in these strategies, although some clients have explored synthetically converting long-term fixed-rate borrowings to floating.
• Nonetheless, we continue to see substantial activity from clients hedging against rising interest rates.
• Although wholesale borrowing hedging comprised the lion’s share of liability-sensitive hedging activity at the beginning of the year, we have seen clients express a preference to use fixed-rate assets in recent weeks, given the flexibility afforded by the Portfolio Layer Method.
• Despite continued upward pressure on interest rates, borrower hedging programs were extremely active the last few weeks as borrowers and banks alike looked to close deals. Swaps continue to offer borrowers substantially lower rates than can be achieved with an unhedged floating-rate loan or traditional fixed-rate pricing. As the third quarter gets underway, we expect borrower hedging activity to remain elevated.

Employment reports diverge, manufacturing data disappoints

• Last week’s June non-farm payroll release garnered significant investor attention, along with the ADP employment report and several manufacturing-related releases.
• According to the Labor Department, the U.S. economy added 209,000 jobs in June, moderately lower than the consensus estimate and far below the robust 339,000 jobs added in May.
• Notably, wage pressures remain firm as average hourly earnings increased 0.4% in June, modestly above expectations and in line with the upwardly revised May monthly change.
• Despite the softening in hiring, investors expect the strength of the release to give the FOMC the green light to raise the policy rate at the next FOMC meeting at the end of the month.
• Interestingly, the ADP employment report diverged significantly from the non-farm payroll release, reporting a robust 497,000 private sector jobs in June against a moderate decline in private sector jobs per the non-farm payroll report.
• On the manufacturing front, the updated data suggested contracting activity levels.
• The national ISM Manufacturing Index fell deeper into contractionary territory in June but also reported softening price pressures.
• Factory orders fell notably below expectations and showed comparable levels of growth to the month prior.

The look forward

Upcoming economic data releases

• Wholesale Inventories – Monday
• MBA Mortgage Applications – Wednesday
• Consumer Price Index – Wednesday
• Producer Price Index – Thursday
• Jobless Claims – Thursday
• University of Michigan Consumer Sentiment Index – Friday

Upcoming Federal Reserve Speakers

• Barr, Daly, Mester, Bostic – Monday
• Barkin, Kashkari, Bostic, Mester – Wednesday
• Waller – Thursday

Rates snapshot

Market implied policy path (overnight indexed swap rates)