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Market Update

Rates rise as Fed officials preach patience

Date:
September 11, 2023
  • william smith headshot

    Authors

    Bill Smith

    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA

Summary

In a holiday-shortened week, Treasury yields climbed higher across the curve as investors digested better-than-expected service economy data and Fed officials preached patience during the latest stage of the monetary policy cycle.

Rates climb amid strong service economy data, “patient” Fed

  • Treasury yields rebounded last week after falling notably the week prior, amid a much better-than-expected ISM Services Index reading and a robust Fed official speaking calendar.

Hedging activity mixed in the first week of September

  • Clients implemented a balanced mix of balance sheet hedging strategies during the holiday-shortened week.

ISM Services report tops expectations, sends rates higher

  • Although economic data releases were in short supply last week, market participants reacted strongly to the much better-than-expected ISM Services Index release, among others.

Rates climb amid strong service economy data, “patient” Fed

  • Treasury yields rebounded last week after falling notably the week prior, amid a much better-than-expected ISM Services Index reading and a robust Fed official speaking calendar.
    • The 2-year yield climbed 11 basis points during the week to 4.98%, while the 10-year yield rose a more modest eight basis points to 4.26%.
    • The more substantial increase at the short-end flattened the curve and sent the 2s/10s basis below its yearly average of -0.68%.
  • A host of Federal Reserve officials held speaking engagements last week, and most expressed a need for patience as we enter the latest stage of the monetary policy cycle.
    • Boston Fed President Susan Collins and Fed Governor Christopher Waller suggested the policy rate could be at its peak, with Waller emphasizing a desire to “proceed carefully” given that “there is nothing that is saying we need to do anything imminent anytime soon.”
    • Cleveland Fed President Loretta Mester took a slightly more hawkish stance, arguing that the FOMC may “have to go a bit higher” to ensure price pressures move toward the Fed’s 2% target.
    • Since Fed Chair Powell’s Jackson Hole speech at the end of August, most officials have expressed a view that the FOMC is now near to or at the end of the historic tightening cycle that began in the first quarter of last year.
  • Last week’s solid data and the continued “higher for longer” narrative pushed by Fed officials drove market participants to increase their expectations slightly for a final 25 basis point hike in 2023.
    • As of Friday’s close, market participants placed a roughly 50% probability on a hike before year-end but saw virtually no chance of a hike at the next FOMC monetary policy meeting in late September.

Hedging activity mixed in the first week of September

  • Clients implemented a balanced mix of balance sheet hedging strategies during the holiday-shortened week.
  • Financial institutions protecting their balance sheets against a rising rate environment continue to represent the lion’s share of hedging activity crossing our balance sheet strategies desk this year, and we saw more of that activity last week.
    • Fair value hedging strategies leveraging the improvements afforded by the Portfolio Layer Method (PLM) proved most popular with clients looking to either portfolios of fixed-rate loans or fixed-rate AFS securities as support for the hedge accounting relationship.
    • Wholesale borrowing hedging remains popular given the increased reliance on wholesale funding across the banking sector, but lags PLM implementations this year.
  • Clients protecting against a falling interest rate environment increased activity levels last week due to the rise in rates and the relative improvement in the economics of those transactions.
    • Looking at the balance sheet items used to support these transactions, most clients have leveraged floating-rate loan portfolios, with back-to-back swap programs typically serving as a good host, while others have utilized fixed-rate term borrowings in smaller numbers.

ISM Services report tops expectations, sends rates higher

  • Although economic data releases were in short supply last week, market participants reacted strongly to the much better-than-expected ISM Services Index release, among others.
  • The August ISM Services Index report topped all estimates in Bloomberg’s survey of economists before the release and rose to a six-month high.
    • New orders and hiring levels led the charge higher and pushed the index further into expansionary territory.
    • Unlike the manufacturing industry, the service economy has shown strength since the early days of the pandemic, experiencing only one contractionary ISM reading since the summer of 2020.
    • Although market participants welcomed the strong ISM data, the report also suggested price pressures are firming as the “prices paid” component of the report moved higher.
  • On the other hand, S&P Global’s measure of the U.S. service economy slipped to its lowest reading since January 2023 but, notably, remained in expansionary territory for the seventh consecutive month.
    • Interestingly, the inflation component of this report contradicted the ISM release and fell to its lowest level since February 2023.

The look forward

Upcoming economic data releases

  • Consumer Price Index – Wednesday
  • MBA Mortgage Applications – Wednesday
  • Retail Sales – Thursday
  • Producer Price Index – Thursday
  • Jobless Claims – Thursday
  • Empire Manufacturing Index – Friday
  • Industrial Production – Friday
  • University of Michigan Consumer Sentiment – Friday

Upcoming Federal Reserve Speakers

  • No speakers – blackout period before September 20 FOMC monetary policy meeting

Rates snapshot

Market implied policy path (overnight indexed swap rates)

Source: Chatham Financial

About the author

  • Bill Smith

    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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