Omicron variant rattles markets; President Biden nominates Powell for second term
- November 29, 2021
Balance Sheet Risk Management
Financial Institutions | Kennett Square, PA
After moving higher for much of the week on the back of positive economic data releases, both equities and Treasury yields fell notably on Friday as market participants grew fearful of the new COVID-19 omicron variant that was first reported in South Africa and has started to spread globally.
- While the week was shortened in the U.S. due to the Thanksgiving holiday, market participants were not without economic releases as investors received updates on new and existing home sales, second-quarter GDP, jobless claims, and manufacturing activity.
- Existing home sales defied calls for a decline and instead rose 0.8% in October to 6.34 million annualized sales, a nine-month high.
- Although monthly sales peaked roughly one year ago, existing home sales are currently on track to top six million sales this year, a 15-year high.
- On the contrary, new home sales fell below the consensus expectation but clocked in above the revised September reading at 745,000 annualized sales.
- While it is no surprise that home prices are elevated, the latest report indicated that the median new home sales price jumped 18% year-over-year to $407,700.
- Still, the strength in both the existing and new home sales figures for October suggests that demand remains strong even in the face of elevated prices.
- According to a report released by the Commerce Department on Wednesday, the U.S. economy expanded at a 2.1% annualized pace in the third quarter, up from the 2% initial estimate released last month.
- Digging into the report, increases in both personal consumption and government spending drove the second estimate higher than the initial estimate.
- Looking forward, the Atlanta Fed’s GDPNow tool, which attempts to forecast the current quarter’s GDP in real-time, currently forecasts the U.S. economy to expand at a robust 8.6% annualized pace in the fourth quarter.
- The labor market has continued to recover from the COVID-19 pandemic, with weekly jobless claims falling to the lowest level since 1969 at 199,000 claims for the week of November 20.
- Analysts were quick to note that the Thanksgiving holiday may have introduced noise in this week’s reading, which led to the large drop in claims.
- Continuing claims have also trended downward, with the most recent release showing continuing claims falling to 2.05 million, down from 2.1 million claims the week prior.
- Finally, manufacturing activity looks to be improving with the Chicago Fed National Activity Index faring far better than the consensus estimate. This release, coupled with the strong readings from the Empire Manufacturing Index and Philadelphia Fed Business Outlook Survey from the week prior, suggests a robust national ISM Manufacturing Index reading may be in the offing.
FOMC minutes and Fed speak
- According to the minutes of the November 2–3 FOMC monetary policy meeting, Federal Reserve officials highlighted the importance of maintaining flexibility in how they implement policy adjustments.
- Notably, officials agreed that, “the committee should be prepared to adjust the pace of asset purchases and raise the target range for the federal funds rate sooner than participants currently anticipated if inflation continued to run higher than levels consistent with the committee’s objectives.”
- Raphael Bostic, Atlanta Federal Reserve Bank President and one of the few Fed speakers this week, offered a similar sentiment in an interview on Monday arguing that a faster pace of asset purchase reductions may be warranted given the rapidly improving labor market and rising price levels.
President Biden nominated Powell for Fed Chair, taps Brainard for Vice-Chair
- On Monday, President Biden announced that he would nominate current Federal Reserve Chair Jerome Powell for a second term as head of the central bank because, “we need stability and independence at the Federal Reserve.”
- President Biden also nominated Lael Brainard, a member of the Federal Reserve Board of Governors, to replace Richard Clarida as Vice-Chair of the Federal Reserve.
- After mid and long-term Treasury yields pushed 10–15 basis points higher during the first three days of the week, Treasury yields dropped substantially on Friday to end the week 5–7 basis points lower than where they started the week.
- As the omicron variant adds uncertainty about future growth, market participants eased bets for Fed rate hikes, with the first hike now expected in July 2022 as opposed to June 2022 on Wednesday.
- Expectations for the second hike remain relatively unchanged on a week-over-week basis, with the second hike expected in December 2022.
- As yields fell, so too did inflation expectations.
- After hitting a multi-decade high of 3.20% in mid-November, the five-year breakeven inflation rate has fallen significantly to approximately 2.95%, representing a nine basis point decline over the week.
- Unsurprisingly, the curve, as measured by the 2s/10s basis, is now flatter on the week with the 2s/10s spread falling approximately seven basis points to 0.97%.
- With Treasury yields taking a breather on Friday, the relative cost of entering into a three-year pay-fixed Fed Funds interest rate swap has also seen a notable decline with the negative carry on a three-year structure sitting at 74 basis points on Friday, compared to 89 basis points on Wednesday.
Excess liquidity alters FHLB customer mix
- It comes as no surprise that the banking system continues to be flush with liquidity. Financial institutions saw a 2.7% quarter-over-quarter increase in deposit inflows in the third quarter, up from the 1.7% increase seen in the second quarter.
- With financial institutions flush with liquidity and having a smaller appetite for wholesale funding, financial institution borrowings have dropped significantly across the Federal Home Loan Bank network.
- According to S&P Capital IQ, commercial banks accounted for just over 60% of total advances from 2015 to 2019.
- Looking at the third quarter of 2021, commercial banks now make up only 35% of total advances, with insurance companies poised to eclipse commercial banks as the FHLB’s largest customer segment.
The look forward
Upcoming economic data releases
- Dallas Fed Manufacturing Activity Index – Monday
- Conference Board Consumer Confidence Index – Tuesday
- ADP Employment Report – Wednesday
- Construction Spending – Wednesday
- ISM Manufacturing Index – Wednesday
- Jobless Claims – Thursday
- November Non-Farm Payroll Report – Friday
- ISM Services Index – Friday
- Factory Orders – Friday
- Durable Goods Orders – Friday
Upcoming Federal Reserve Speakers
- Powell, Williams, Hassan, Bowman – Monday
- Powell (and Yellen), Williams, Clarida – Tuesday
- Powell (and Yellen) – Wednesday
- Bostic, Quarles, Daly, Barkin – Thursday
- Bullard – Friday
Market implied policy path (Overnight indexed swap rates)
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