Regulators voice support for SOFR
- July 12, 2021
Balance Sheet Risk Management
Financial Institutions | Kennett Square, PA
Prior week summary
Despite the recent rise in COVID-19 cases linked to the delta variant and weaker-than-expected economic data, the major U.S. equity indices extended their run last week, setting new all-time highs, while long-term Treasury yields continued their drift lower, falling to multi-month lows. While long-term yields have moved lower in recent weeks, the downward move accelerated last week with the 10-year Treasury yield falling as low as 1.25%, a level not seen since February. According to analysts, the move has been precipitated by a confluence of economic variables, namely concerns of a slowdown in the global recovery stemming from the increased spread of the delta variant, robust foreign demand for Treasuries, and an unwinding of short positions entered into during the first half of the year. Expectedly, inflation expectations have declined in tandem with the decline in Treasury yields as investors bet that the recent pick-up in inflation will prove short-lived. The 10-year breakeven inflation rate fell just over four basis points and sat as low as 2.23% on Thursday, a level also not seen since February. The pull-back in yields has called into question the strength and durability of the reflation trade that drove equities and yields higher during the first quarter of this year. The 10-year Treasury yield ended the week at 1.37%, over 35 basis points lower than the highs seen in March. As investors continue to search for clues on what’s next for rates, Wednesday’s release of the Fed minutes provided insights into discussion held at the more hawkish-than-expected June FOMC meeting. In the latest meeting, Fed officials broadly spoke about tapering their $120 billion per month asset purchase program but mostly agreed that the U.S. economy has failed to reach “substantial further progress,” a key milestone that will likely need to be reached before the FOMC winds down the asset purchase program. According to the minutes, “In coming meetings, participants agreed to continue assessing the economy’s progress toward the Committee’s goals and to begin to discuss their plans for adjusting the path and composition of asset purchases. In addition, participants reiterated their intention to provide notice well in advance of an announcement to reduce the pace of purchases.”
Economic data releases during the holiday-shortened week were light, yet market participants received a few key updates. The ISM Services Index fell moderately below expectations, posting a 60.1 level, a notable decline from the record-setting 64.0 level reached in May. As the U.S. economy looks to leave the pandemic in the rear-view mirror, many consumers have shifted purchases more heavily into the service economy as restrictions lift around the country. To that end, 16 of the 18 measured industries reported growth in June, although much of June’s commentary focused on the continued supply chain issues that have hindered the ability of many businesses to meet robust demand. Thursday’s release of the weekly jobless claims figure reported 373,000 claims for the week of July 3, above both expectations and the week prior’s reading. While jobless claims ticked up week over week, the most recent update continues to suggest a recovering U.S. labor market as claims continue to drift closer to pre-pandemic levels. Additionally, continuing claims notched a moderate decline falling to 3.339 million claims. While continuing claims drifted lower, the absolute level of claims remains significantly elevated.
With the LIBOR transition increasingly coming into focus ahead of year-end and the “SOFR First” initiative expected to launch later this month, the regulators have turned up the volume on their commitment to SOFR as the preferred alternative to LIBOR. The Financial Stability Board published a LIBOR transition progress report last week that outlined the most recent developments and the hurdles to overcome between now and year-end. In a statement released with the report, John Williams, President of the Federal Reserve Bank of New York, emphasized the importance of adopting a rate grounded in a robust market with ample liquidity saying, “In these final months until no new LIBOR, remember: we never want to repeat this transition again. So for the sake of global financial stability, choose robust, enduring reference rates. For US dollar LIBOR, that means building the transition on an unshakeable SOFR foundation.”
The look forward
In a holiday-shortened week, market participants are gearing up for updated figures on the ISM Services Index, wholesale inventories, and jobless claims, among others. The Minutes of the FOMC’s June meeting are released on Wednesday.
Market implied policy path (Overnight indexed swap rates)
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