Quiet week marks end to solid year for equities
- January 3, 2022
Balance Sheet Risk Management
Financial Institutions | Kennett Square, PA
The major U.S. equity indices ended the year on a high note, capping an end to a stellar year for equity returns, while treasury yields advanced modestly across the curve in a light week for trading to end the year notably higher than where they began. The three major U.S. equity indices notched their third consecutive yearly gain with the S&P 500 advancing an impressive 26.89% for the year in the face of significant headwinds ranging from transmissible COVID-19 variants and persistent supply chain disruptions to political wrangling in Washington and accelerating consumer prices. Meanwhile, expectations for Fed action increased dramatically over the year as market participants placed bets on how fast and how far the Fed would look to raise interest rates in the coming years as the labor market improves and prices move higher.
- In a quiet week for economic data releases, market participants received several updates on the manufacturing industry, as well as the labor market.
- Released last week were several regional manufacturing reports that painted a mixed picture of the industry.
- The Dallas Fed regional manufacturing survey defied calls for an increase and instead fell to 8.1, the lowest level since September.
- Declines in both the new orders and shipments segments primarily drove the miss.
- On the contrary, the Richmond Fed regional manufacturing survey reported a significant increase on the back of robust increases in new orders, shipments, and more broadly, capacity utilization.
- Consistent with the modest increases seen in the Empire Manufacturing Index earlier in December, the MNI Chicago PMI improved very modestly to 63.1.
- With the regional manufacturing indices painting mixed pictures for the state of the manufacturing industry, all eyes will turn to Tuesday’s release of the national ISM Manufacturing Index for a more complete picture.
- Finally, jobless claims unexpectedly declined for the week of December 25, falling to 198,000 claims compared to the 206,000 claims seen the week prior.
- Continuing claims declined to 1.72 million, the lowest level since March 2020.
Omicron variant causes headaches
- The omicron variant continued to spread in earnest across the world during the holiday season with the Centers for Disease Control and Prevention reporting a record 486,400 cases on Wednesday alone, roughly 1.6x the highest daily case tally reported in the U.S. during last January’s surge.
- Airline cancelations accelerated dramatically during the holiday season with thousands of flights canceled globally in the last week.
- Over 4,700 flights were canceled on New Year’s Day, as staffing shortages plagued airlines due to the rapidly spreading omicron variant.
- While the latest daily case counts set records globally, several studies, including those from researchers in South Africa and the U.K., have released preliminary data in the last two weeks indicating that the omicron strain is far less virulent than its predecessors likely resulting in fewer hospitalizations and deaths.
- Although the latest case counts are roughly 1.6x last January’s peak, deaths remain notably lower than last January with the 7-day average death toll sitting at 1,100 deaths currently compared to the 3,400 death average seen at the height of last January’s surge.
- As the omicron variant surges across the country, the Food and Drug Administration authorized the first oral antiviral treatments for emergency use when it approved Pfizer’s Paxlovid and Merck’s Molnupiravir just before Christmas.
- The new pills are authorized for use in individuals with “mild-to-moderate” cases of COVID-19 and who are at high-risk “for progression to severe COVID-19, including hospitalization and death.”
- Proponents of the new treatments hope the pills will limit the number of severe cases that could potentially overrun U.S. hospitals as daily omicron case tallies continue to set records into the new year.
- In a light week for trading, treasury yields traded in a tight range, pushing very modestly higher across the curve.
- The 10-year Treasury yield closed the year at 1.52%, notching a 61 basis point increase in 2021.
- While rates have climbed over the year, the curve as measured by the 2s/10s basis remains relatively unchanged from one year ago.
- The 2s/10s basis closed the year at 77 basis points, two basis points lower than where it started the year.
- At its height, the 2s/10s basis reached as high as 157 basis points in late March.
- Inflation expectations also increased substantially over the year with the five-year breakeven inflation rate sitting at 2.91% on Friday, roughly 92 basis points higher than where it started the year.
- The pick-up in inflation expectations is no surprise as price increases accelerated globally in the last year exacerbated by several waves of COVID-19 infections and government stimulus.
- The majority of trading activity on our desk was geared toward hedging for higher rates at the start of the year, but gradually turned more balanced as short-term yields picked up and expectations for Fed rate hikes pulled forward.
New year, no new USD LIBOR contract
- At the direction of the Board of Governors of the Federal Reserve System, the Office of the Comptroller of Currency, and the Federal Deposit Insurance Corporation, U.S. financial institutions will no longer be permitted to execute new USD LIBOR contracts after December 31, 2021, except for the following reasons:
- “Transactions executed for purposes of required participation in a central counterparty auction procedure in the case of a member default, including transactions to hedge the resulting USD LIBOR exposure.”
- “Market making in support of client activity related to USD LIBOR transactions executed before January 1, 2022.”
- “Transactions that reduce or hedge the bank’s or any client of the bank’s USD LIBOR exposure on contracts entered into before January 1, 2022.”
- “Novations of USD-LIBOR transactions executed before January 1, 2022.”
- As always, please reach out to a member of our Financial Institutions team with questions.
Lending at U.S. banks improves in December
- Many financial institutions spoke of improving loan demand during the Q3 earnings season, and now those anecdotes are beginning to show up in the data.
- According to data released by the Federal Reserve, total loans and leases as a percentage of total assets rose to 47.09% in the final week of December, the highest level since September 2021.
- Commercial and Industrial (C&I) loans, in particular, look to be improving as the asset class made up approximately 11% of commercial banks’ total assets in the final week of December, the highest level since August.
- The pick-up in C&I loan growth is a welcomed development for the banking industry as C&I loan volumes declined 4% sequentially, in aggregate, in the third quarter.
The look forward
Upcoming economic data releases
- Markit U.S. Manufacturing PMI – Monday
- Construction Spending – Monday
- ISM Manufacturing Index – Tuesday
- ADP Employment Report – Wednesday
- FOMC Meeting Minutes – Wednesday
- Jobless Claims – Thursday
- Factory Orders – Thursday
- ISM Services Index – Thursday
- Durable Goods Orders – Thursday
- December Non-Farm Payroll Report – Friday
Upcoming Federal Reserve Speakers
- Bullard – Thursday
- Daly, Bostic – Friday
Market implied policy path (Overnight indexed swap rates)
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.22-0001
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