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Market Update

Rates continue to rise; big banks report active hedging

Date:
October 25, 2021
  • william smith headshot

    Authors

    Bill Smith

    Associate Director
    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA

Summary

Building on weekslong momentum, the major U.S. equity indices continued to move higher last week with the S&P 500 and Dow Jones Industrial Average each setting new all-time highs. Rates all along the Treasury curve, particularly in the mid and long-term part of the curve, pushed higher on the back of mixed economic data and hawkish comments from Federal Reserve officials.

Economic data

  • While not the busiest week on the economic calendar, several high-profile pieces of data were released last week particularly in the housing sector.
  • Unsurprisingly, supply chain disruptions remained in focus last week when reports indicated that new home sales increased at a 1.56 million annualized pace.
    • While homebuilder sentiment sits at a three-month high, headwinds for the industry appear on the horizon with applications to build falling 7.7%, the largest monthly decline since February, and construction backlogs remaining near a 15-year high.
  • On the contrary, existing home sales topped the consensus estimate and increased at a 6.29 million annualized pace in September, a notable improvement from the 5.88 million annualized pace seen in August and the strongest reading since January.
    • While rising home prices and higher mortgage rates have cooled home buyer demand somewhat in recent months, the latest existing home sales reading suggests that demand remains firm.
  • Industrial production fell 1.4% in September defying analyst calls for a modest pick up as the effects of Hurricane Ida and vehicle component shortages soured an otherwise encouraging report.
    • Semiconductor shortages appeared to remain top of mind for vehicle makers with vehicle production falling 7.2% last month.
  • Finally, jobless claims for the week of October 16 moved modestly lower to a pandemic-era low of 293,000 claims.

Beige Book and Fed Speak

  • The Federal Reserve released the latest Beige Book on Wednesday.
    • Notably, respondents highlighted “significantly elevated prices” due to strong goods and raw materials demand and labor and commodity shortages.
    • While many Districts reported slowing economic activity, most Districts reported a pickup in consumer spending.
  • Fed Chair Powell spoke at a virtual event on Friday.
    • During the discussion, Powell expressed support for an imminent launch to the tapering program with an end to the program coming by the middle of 2022, but emphasized that, “I don’t think it is time to raise rates.”
    • Powell admitted that the pandemic-driven supply chain constraints, “are likely to last longer than previously expected,” but remained confident that price increases will prove temporary.
    • Currently, the market expects the first rate hike to commence in September 2022.

Interest rates

  • Mid and long-term Treasury yields continued to rise last week with the 10-year Treasury yield surpassing 1.68%, a level not seen since May.
  • After flattening roughly 10 basis points the week prior, the curve steepened approximately four basis points last week, as measured by the 2s/10s basis.
  • Notably, the mid-term part of the curve has seen significant increases in recent weeks.
    • The five-year Treasury yield ended the week at 1.22%, approximately 36 basis points higher than just one month ago.
    • The relative compensation associated with a five-year receive-fixed Fed Funds swap has increased in tandem with the rise in mid-term rates and currently sits just shy of 100 basis points of positive carry.
  • Consistent with the narrative seen for much of October, rate increases have been primarily driven by a rise in inflation expectations.
    • The five-year breakeven inflation rate rose approximately 18 basis points last week to 2.92% as supply chain disruptions and labor shortages continue to affect businesses and industries around the country.

Large U.S. financial institutions report active hedging in Q3

  • With the Q3 earnings season firmly underway, we have seen many financial institutions in the banking industry release positive earnings updates in Q3 and relay encouraging sentiment for loan production in the coming quarters.
  • Several financial institutions have disclosed active hedging programs for Q3 and Q4 including Citizens Financial Group Inc. and Regions Financial Corp.
  • Citizens Financial Group Inc. reported adding $2.5 billion in receive-fixed swaps to, “monetize that asset sensitivity as the yield curve steepens.”
    • According to comments made at the third-quarter conference call, Citizens has already executed another $1.25 billion in hedges at the start of the fourth quarter.
  • Regions Financial Corp. has repositioned its hedge portfolio in the opposite direction of Citizens.
    • Regions reported terminating $5 billion of receive-fixed swaps during the third quarter, a move that positions the bank to fare better in a rising rate environment.
  • The recent commentary from Citizens and Regions is consistent with the activity we have seen on our trading desk in the third quarter and fourth quarter.
    • Asset-sensitive clients have picked up hedging activity in the latter half of the third quarter as rates have climbed across the curve and the relative compensation for entering into a receive-fixed interest rate swap has increased, while our liability-sensitive clients have looked to lock in current levels with the expectation of a rising rate environment materializing.

The look forward

Upcoming economic data releases

  • Chicago and Dallas Fed Manufacturing Activity Index – Monday
  • New home sales – Tuesday
  • Conference Board Consumer Confidence Index – Tuesday
  • Wholesale inventories – Wednesday
  • Durable goods orders – Wednesday
  • Jobless claims – Thursday
  • Third-quarter GDP (advance estimate) – Thursday
  • Personal Spending – Friday
  • PCE Deflator – Friday

Upcoming Federal Reserve Speakers

  • There will be no Federal Reserve speakers this week as they enter the blackout period before the November 2–3 FOMC 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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