Powell adds fuel to Treasury sell-off
- March 28, 2022
Balance Sheet Risk Management
Financial Institutions | Kennett Square, PA
The Treasury sell-off continued last week with the 10-year Note climbing 34 basis points and at one point topping 2.50% as investors priced in expectations for an aggressive Fed hiking cycle following Federal Reserve Chair Jerome Powell’s hawkish comments.
- The Treasury sell-off that has persisted for the entirety of March continued last week as yields across the curve moved substantially higher on the back of an increase in both inflation expectations and Fed rate hike expectations.
- Fed Chair Jerome Powell turned heads on Monday when he commented on raising the federal funds rate more than a quarter-point at a meeting saying, “If we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so.”
- Expectations for a 50 basis point hike at the May meeting moved considerably higher on the back of those comments, with current market pricing suggesting a roughly 80% chance of a half-point hike in May.
- Further, market participants priced in a more aggressive Federal Reserve in 2022 with the Fed Funds futures market pricing suggesting the Fed will raise over eight quarter-point hikes at this year’s six remaining Federal Reserve meetings, implying at least two half-point hikes this year.
- Notably, many of the largest U.S. financial institutions updated their forecasts for 2022 rate hikes last week with Bank of America calling for half-point hikes in June and July and quarter-point hikes at all other meetings, while Citigroup expects half-point hikes at the next four meetings, a notable shift from both institutions’ outlooks at the start of the year.
- While inflation expectations headed lower to start the year, the five-year forward, five-year breakeven inflation rate has moved substantially higher during this month’s Treasury sell-off with the measure sitting at 2.38% on Friday, roughly 35 basis points higher than the yearly low seen on February 18.
- Finally, the 2s/10s basis continued to narrow to 18 basis points, just two basis points above the recent lows seen in March 2020.
- As we have mentioned previously, the continued volatility seen in Treasury yields has driven elevated hedging activity across our balance sheet desk as asset-sensitive clients look to smooth future earnings in a rising rate environment while liability-sensitive clients look to hedge against further increases in interest rates.
- Looking at some of the activity seen last week, we saw significant activity from clients unwinding AFS security hedges put on during the last two years, as many of these transactions have appreciated significantly in value during this month’s sell-off.
- Separately, we saw several instances of clients monetizing the current shape of the yield curve, executing receive-fixed interest rate swaps, and earning approximately 185-200 basis points of initial relative compensation depending on the tenor and index.
- Our back-to-back desk has also continued to see significant hedging activity from borrowers looking to lock in long-term fixed-rate financing in the face of the expectation for the most aggressive Federal Reserve tightening cycle in recent memory.
- Additionally, unwind activity has picked up significantly, with borrowers opting to take gains from hedges executed over the last several years.
After a period of record lows, credit card charge-offs pick up to start 2022
- After net charge-offs fell to a decade low in September 2021, net charge-offs have been creeping higher at the six largest U.S. credit card issuers to start 2022.
- Average net charge-offs climbed 10 basis points in February, the largest monthly increase in a year, to 1.09% as government stimulus benefits lost steam, sending net charge-offs back toward more normalized levels.
- Notably, average net charge-offs, including February’s gain, remain well below pre-pandemic levels after consumers used excess cash and government stimulus to pay down credit card bills.
- Manufacturing data dominated the economic calendar last week, with several regional manufacturing surveys providing largely positive updates on the state of the U.S. manufacturing industry.
- The Richmond Fed Manufacturing Index improved significantly in March to 13, defying calls for a modest gain as new orders and shipments propelled the index higher.
- Elsewhere, the Chicago Fed National Activity Index pulled back modestly from January’s readings but remained well within expansionary territory.
- Digging into the report, 51 of the 85 measured segments improved in February, with 61 of the measured segments contributing positively to the reading.
- Finally, the S&P Global U.S. Manufacturing Index confirmed many of the regional surveys’ reports, indicating a modest improvement in March as new orders and shipments picked up across the country.
- While the manufacturing industry appears to be faring well, consumer sentiment is dwindling in the face of decades-high inflation and the war in Ukraine according to the latest consumer sentiment report released by the University of Michigan.
- The latest reading marks the lowest reported level in a decade as roughly one-third of respondents expected their financial condition to worsen in the coming year, a series high dating back to the 1940s.
- In a bright spot, inflation expectations appear to remain anchored in the long term with respondents indicating they see inflation running at approximately 3% for the next 5-10 years, higher than the Fed’s average inflation target but well below the levels consumers are currently experiencing.
- Finally, in a sign of a strong labor market, jobless claims for the week of March 19 fell to 187,000 claims, the lowest level since 1969.
The look forward
Upcoming economic data releases
- Wholesale Inventories – Monday
- Dallas Fed Manufacturing Activity Index – Monday
- Conference Board Consumer Confidence Index – Tuesday
- ADP Employment Report – Wednesday
- 4th Quarter GDP (Third Estimate) – Wednesday
- Core PCE – Wednesday
- Jobless Claims – Thursday
- March Non-Farm Payroll Report – Friday
- ISM Manufacturing Index – Friday
Upcoming Federal Reserve Speakers
- Harker, Bostic – Tuesday
- Barkin, George – Wednesday
- Williams – Thursday
- Evans – Friday
- Williams – Saturday
Market implied policy path (Overnight indexed swap rates)
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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.22-0073
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