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Market Update

Powell sets stage for 50-basis-point hike

Date:
April 25, 2022
  • william smith headshot

    Authors

    Bill Smith

    Associate Director
    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA

Summary

Interest rate volatility continued in earnest last week with the Treasury curve flattening as market participants reevaluated the timing and magnitude of expected FOMC rate hikes in the context of the latest comments from Federal Reserve officials and the week’s economic data.

Interest rates

  • The rate volatility that has become increasingly common since the turn of the year continued last week as the Treasury curve flattened, erasing much of the steepening seen from the week prior.
    • After climbing as high as 37 basis points the week prior, the 2s/10s basis narrowed approximately 15 basis points last week to 0.22%.
    • The flattening came as investors priced in an even more aggressive Fed with current market pricing suggesting a 100% chance of at least 50 basis point hikes at the next three FOMC meetings through July and 2.25% of tightening by year-end.
    • The moves came on the back of hawkish comments from most Fed officials that spoke during the week including from Federal Reserve Chair Jerome Powell with many pundits suggesting that Powell sealed the fate of a 50-basis-point hike in May after making comments that such a move is “on the table in May” during an IMF panel discussion on Thursday.
  • While real yields declined modestly last week, the 10-year real yield briefly crossed zero on Tuesday, a phenomenon not seen since late March 2020.
  • Finally, long-term inflation expectations picked up moderately last week with the Fed-watched 5-year forward, 5-year breakeven inflation rate rising five basis points to 2.56%, above the yearly average of 2.24%.

              Trading commentary

              • As previously reported, the rate volatility in the marketplace often drives elevated activity across our balance sheet risk management desk and last week was no exception.
                • Specifically, we saw the continuation of the income-producing down-rate hedging strategies that have represented the lion’s share of hedging activity crossing our desk since the turn of the year.
                  • Looking at the assets used to deploy these strategies, many clients have looked to the floating rate loan book to support the hedges and have employed the use of receive fixed swaps with many different indices including 1mL, SOFR, Prime, and BSBY.
                • On the other hand, we continue to have many conversations and facilitate the execution of strategies designed to hedge against a continued rise in interest rates.
                  • To that end, many clients are preparing for a need for wholesale funding in the next six to 18 months and are using pay-fixed swaps to lock in the future cost of that funding at current levels.
                • Separately, activity remains robust on our back-to-back trading desk with borrowers eager to lock in long-term fixed-rate financing given the current rate environment.
                  • Activity is expected to be elevated in the coming week as we close out the first month of the second quarter.

                          Big banks raise net interest income guidance

                          • First-quarter earnings season is now in full swing with many large U.S. financial institutions reporting earnings last week
                          • After Wells Fargo increased guidance for full-year net interest income (NII) the week prior, Regions Financial Corp. followed their footsteps last week projecting a 15% increase to NII in the fourth quarter of 2022 compared to the most recent quarter as the bank expects loan demand to continue to improve and now expects more Fed rate hikes than at the end of last year.
                            • Consistent with the activity we have seen on our balance sheet desk in the first quarter, Regions detailed their thinking on entering into forward-starting receive-fixed swap strategies during the first quarter with CFO David Jackson Turner Jr. commenting that the bank is trying to “get our margin to the optimum level and then layer in protection for that margin over time,” and that, “… we believe there is risk at this point in the cycle that actually rates could go the other way, and we want to be able to protect that.”
                          • Bank of America (BoA) reported similar expectations for a pickup in loan growth and margin help from higher interest rates.
                            • While BoA passed on providing full-year net interest income projections, CFO Alastair Borthwick commented that the bank is well-positioned for a rise in interest rates and that encouragingly the bank has seen a return of commercial line utilization near pre-pandemic levels.

                                                    The look forward

                                                    Upcoming economic data releases

                                                    • Chicago Fed National Activity Index – Monday
                                                    • Dallas Fed Manufacturing Index – Monday
                                                    • Durable Goods Orders – Tuesday
                                                    • Conference Board Consumer Confidence Index – Tuesday
                                                    • New Home Sales – Tuesday
                                                    • Wholesale Inventories – Wednesday
                                                    • First-quarter GDP (Advance estimate) – Thursday
                                                    • Jobless Claims – Thursday
                                                    • Core PCE – Thursday
                                                    • University of Michigan Consumer Sentiment Index – Friday

                                                                                  Upcoming Federal Reserve Speakers

                                                                                  • There will be no Federal Reserve speakers this week as they head into the blackout period prior to the May 3–4 FOMC monetary policy meeting.

                                                                                                                  Rates snapshot

                                                                                                                  Market implied policy path (Overnight indexed swap rates)

                                                                                                                  Source: Chatham Financial

                                                                                                                  About the author

                                                                                                                  • Bill Smith

                                                                                                                    Associate Director
                                                                                                                    Balance Sheet Risk Management

                                                                                                                    Financial Institutions | Kennett Square, PA


                                                                                                                  Disclaimers

                                                                                                                  Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

                                                                                                                  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.

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