Rates higher but curve flatter as market sees hawkish Fed

Short end of yield curve up dramatically

Amid a broader trend of yield curve steepening and flattening, the dynamic accelerated this week, as market participants began to price in even higher expectations for Fed rate hikes this year and next. Just a week ago, market expectations for the Fed Funds rate at year-end hovered around 2.0%; now, those expectations have risen to 2.4%, a move that would require hikes at every remaining Fed meeting. Moreover, the figure includes some “double hikes” reflecting the possibility of the Fed hiking half a percentage point, rather than the customary quarter percentage point. Wall Street predictions of such a dynamic may have fueled the change, though speeches by Fed policymakers, including the influential John Williams of the New York Fed district, seemed to corroborate a willingness to use 50 basis point hikes as necessary. Williams and other Fed speakers noted the ongoing challenges associated with inflation and spillover effects from the Russian invasion of Ukraine. As such, the 2-year swap rate rose as much as 15 basis points intra-day on Friday, capping a climb of almost 90 basis points from the beginning of March. While longer-term yields have risen as well, they have risen at a much slower pace, resulting in a continued flattening of the yield curve. To compare to the precipitous rise of the 2-year since the beginning of March, the 10-year yield has only risen 60 basis points in that time frame. The result is the flattest curve the market has seen in over a decade.

Implications on hedging

Hedging implications abound in this volatile market. Companies looking to convert floating-rate debt to fixed need not feel they have completely missed the boat; indeed, the flat curve allows an opportunity to lock in a longer-term risk (e.g. 7-years) at a lower swap rate than they would for a medium-term risk (e.g. 5-years). Companies fulfilling hedge requirements are also electively locking in a longer term. On the fixed-rate issuance side, the flat curve provides an enticing opportunity for companies to lock in longer-term yields that are historically low given the flat curve, especially for an economy that is ostensibly still in growth mode.

(Related insight: Read "Hedging future fixed-rate debt")

Continued oil volatility in oil

After peaking over $130 per barrel and subsequently dipping back below $100 per barrel (albeit very briefly), crude has steadily climbed back to the $119 per barrel level as of this week. The drivers are numerous; while the impact of sanctions on Russian energy continues to dominate commodity markets, this week saw an attack on Saudi oil from Houthi rebels in Yemen that served to put further upward pressure on prices. Forward contracts for oil continue to be backwardated, meaning companies can lock in future contracts at lower prices than current spot. While many companies may be reticent to lock in during such a volatile market, those same companies are prioritizing getting their hedging documentation in place so they can be ready to move quickly when the market befits their particular hedging strategies.

(Related insight: Read "7 ways to maximize FX and commodity hedging impact while minimizing costs")