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Market Update

Rates drop on “Goldilocks” NFP

January 9, 2023
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    Bill Smith

    Associate Director
    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA


Treasury yields dropped substantially to start the new year, most notably at the long end, as investors digested a slew of manufacturing and employment data and recalibrated Fed policy rate expectations.

Interest rates

  • Continuing the volatility experienced in 2022, Treasury yields fell substantially across a more-inverted curve last week.
    • The 2-year Treasury yield fell 17 basis points to end the week at 4.24%, while the 10-year yield fell an even greater 33 basis points to finish at 3.55%.
    • The outsized decline at the long end of the curve pushed the 2s/10s basis further into negative territory at -0.70%, notching the lowest level since mid-December and reigniting the flattening trend that investors experienced for much of the second half of last year.
  • Looking at Fed Funds futures pricing on Friday, policy expectations for the first half of this year are roughly unchanged, with investors anticipating two to three 25 basis point hikes from now until June 2023.
    • Expectations further into the future declined significantly, however, as investors now expect the policy rate to be lower than current levels one year from now.
    • Although market participants lowered their policy rate expectations last week, Fed policymakers reaffirmed their commitment to higher rates for longer, a notable divergence between Fed policymakers and investors.
      • The minutes from the December FOMC meeting, released Wednesday, spoke directly to this divergence and cautioned that “an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the committee’s reaction function, would complicate the committee’s effort to restore price stability."
  • Finally, real yields declined to start the year as the substantial decline in nominal yields drove real rates lower despite the modest drop in inflation expectations.
    • Looking at the real Treasury curve, the 5-year real yield fell 15 basis points to 1.51%, while the 10-year real yield dropped 24 basis points to end the week at 1.34%.

    Trading commentary

    • Hedging activity crossing our balance sheet strategies desk remained robust as we entered the new year.
    • The most prevalent themes in 2022 continued into the new year, with asset-sensitive institutions primarily leveraging hedges against the floating rate loan portfolio to reduce falling rate exposure and achieve favorable hedge accounting treatment and liability-sensitive clients utilizing hedges against either fixed-rate assets or wholesale borrowings to protect against further increases in interest rates.
      • Although rising rate hedges, particularly those leveraging the new Portfolio Layer Method, have increased in recent weeks, hedges designed to protect against a falling interest rate environment continue to see the lion’s share of executions and comprise approximately 70-80% of all the hedging activity we have seen cross our desk since the second quarter of last year.

      CRE delinquencies fall in Q3

      • According to an analysis by S&P Capital IQ, delinquency ratios in U.S. banks’ CRE portfolios dropped significantly in the third quarter.
      • After seeing modest increases in the first half of the year, the aggregate delinquency ratio ticked down in the third quarter by 25 basis points to 0.58%.
        • The industry average CRE delinquency ratio currently sits at its lowest level since late 2019 and marks a stark drop from the recent high of approximately 1.1% seen in the fourth quarter of 2020.

      Economic data

      • Market participants were the beneficiaries of a deluge of economic updates to start the year.
      • On the manufacturing front, the outlook continues to worsen.
        • Although the national ISM Manufacturing reading landed near analyst expectations, December’s sub-50 reading marks the second consecutive month that the measure indicated the manufacturing sector is in contraction.
        • The dismal outlook was further reinforced by downbeat readings on the S&P Global US Manufacturing PMI and factory orders during the week, which suggested falling activity levels.
        • In a bright spot, the “prices paid” component of the ISM release showed far greater easing of inflationary pressures than anticipated by market participants leading up to the report’s release.
      • Despite the robust economic calendar last week, the December non-farm payroll report garnered the most investor attention last week.
        • According to the Labor Department, the U.S. economy added 223,000 jobs in December, just above analyst expectations but below the downwardly revised 256,000 jobs added in November.
        • The report was generally viewed favorably as the pickup in jobs was accompanied by a bigger-than-expected drop in the pace of hourly earnings increases, suggesting an easing of inflationary pressures

        The look forward

        Upcoming economic data releases

        • Wholesale Inventories – Tuesday
        • MBA Mortgage Applications – Wednesday
        • Consumer Price Index – Thursday
        • Jobless Claims – Thursday
        • University of Michigan Consumer Sentiment – Friday

          Upcoming Federal Reserve Speakers

          • Bostic, Daly – Monday
          • Powell – Tuesday
          • Harker, Bullard, Barkin – Thursday

            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


            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

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