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Market Update

Rates uncertainty continues as investors interpret consumer data

Date:
May 23, 2022
  • kevin jones headshot

    Authors

    Kevin Jones

    Director
    Treasury Advisory

    Corporates | Kennett Square, PA

Summary

Interest rates continued their choppy trajectory last week as market data offered mixed narratives; retail sales data suggested continued strength in the U.S. consumer sector while manufacturing data portended future weakness in the economy. Meanwhile, dollar strength continues unabated.

Rate volatility is ongoing

Market data and swinging investor sentiment continue to drive substantial volatility in interest rate markets. After peaking at 3.13% two weeks ago, the 10-year Treasury has since fallen roughly 40 basis points, ending the week around 2.80%. Shorter-term rates have been somewhat less sensitive, but markets have still reacted to the mix of market data and economic sentiment. On market data, retail sales data released this week showed fairly strong consumer purchasing, suggesting that inflation is not yet holding back consumers in a significant way. Moreover, as poor earning data from Target and Wal-Mart shocked Wall Street, those corporations implied inflation was impacting their cost inputs more than it was impacting consumer behavior. On balance, this anecdote suggests corporations are bearing the brunt of inflation, at least for now.

Weaker manufacturing data also suggests firms are struggling with price inputs. Data from the Empire State Manufacturing index showed the second negative monthly reading in three months, a sign of contracting manufacturing activity. The Philadelphia Fed Manufacturing index similarly showed a weak, albeit positive number. As investors grapple with the impact of inflation on producers and consumers alike, the tension between rate hikes driving higher interest rates and risk-off sentiment pushing rates down continues to add sensitivity to rate markets.

Dollar strength continues unabated

The mix of U.S. inflation and safe-haven flows continues to drive dollar strength. After the dollar’s strength peaked against the euro last week, reaching 1.0368 (intraday), the EUR improved somewhat to between 1.05 and 1.06 this week, though most signs continue to point to a strong dollar. Some market participants are beginning to discuss the concept of parity, where 1 dollar is worth 1 euro. This dynamic has not occurred since the existence of the euro but arguably did occur in the pre-EUR multi-European currency paradigm. Lockdowns in China per the country’s zero COVID policy have caused concern over weakening economic activity, driving CNY to almost 6.8 last week, a 15-month high.

Chatham has seen numerous clients react to the stronger dollar by reevaluating FX hedging programs and restructuring cross-currency swaps. On the FX hedging side, the weakness in foreign currencies has shone a spotlight on particular exposures that may not have received as much attention before. On cross-currency swaps, many companies have taken the opportunity to restrike hedges and more favorable rates and simultaneously cashing out on asset positions. In either case, a fresh examination of these positions is warranted given the current state and future outlook.

(Related insight: Read, "Cross-currency swaps: an in-depth guide for corporates")

Widened “crack spread” capturing market attention in commodities markets

On energy headlines, crude oil has fallen from recent peaks, dropping below $110 per barrel briefly this week. That said, prices for refined products remain much higher. Diesel and jet fuel, typically priced around $10-$15 per barrel above crude, remain $40-$50 per barrel higher; refined products thus are pricing as if crude is $40 per barrel higher than it actually is. This dynamic is driven by a series of factors: Global Special Petroleum Reserve (SPR) release has been focused on crude oil but not refined products; diesel was already rallying before Russia invaded Ukraine, and global refining capacity is down (also impacted by Russia).

The above makes hedging energy-related risks all the more complicated. Chatham has been advising its clients to proactively put hedging infrastructure in place — ISDAs, approvals, analysis, accounting, etc. — so that when the time comes to move the company is prepared.

(Related insight: Read, "5 lies corporates tell themselves about commodity risk")

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About the author

  • Kevin Jones

    Director
    Treasury Advisory

    Corporates | Kennett Square, PA

    Kevin Jones serves Chatham’s corporate clients in interest rate and foreign currency hedging advisory. Kevin’s expertise spans risk quantification and analysis, hedging strategy development, market dynamics, and trade execution.

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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