Resilience remains: reason to raise rates?

PMI and ISM readings

Several important indicators of the health of the economy were released last week. On Wednesday, the ISM manufacturing survey rose slightly in February to 47.7% from 47.4% in January. Numbers below 50% indicate a contracting economy. On Friday, the ISM services reading for February held at a steady 55.1% from 55.2% in January which was higher than expected. While the ISM numbers indicated weakness in business conditions for manufacturing, the service sector showed resilience. Similarly, the S&P Global US Service PMI (Purchasing Manager’s Index), released Wednesday, also told the narrative of a strong service sector as the reading for February registered at 50.6, up from 46.8 in January. The strong service sector numbers provide persistent evidence of a strong labor market as the services sector continues to expand and hire employees.

Inflation remains high in the Eurozone

Across the Atlantic, inflation data for February was released on Thursday which eased slightly to 8.5% from 8.6% in January. Core inflation — which removes often volatile food and energy costs — in the Eurozone did rise, however, to 5.6% in February from 5.3% in the previous month. The core reading makes another 50 basis point hike for the European Central Bank (ECB) likely in order to combat high inflation — and this may only be the beginning. With high core inflation numbers, the ECB is now forecasted to reach record-high numbers in the upcoming months.

A dove in a sky full of hawks?

On Thursday, Federal Reserve Bank of Atlanta President Raphael Bostic voiced optimism for the state of interest rates this year in which he expects the Fed to pause interest rate hikes by mid to late summer. Bostic also stated that he remains firm in supporting quarter-point rate hikes amidst some speculation of potential a 50-basis-point rate hike saying, “Slow and steady in this is going to be the appropriate course of action.” While the markets currently expect about a 70% chance of the Fed increasing the Fed funds rate by a quarter point in the next meeting (according to CME Group’s Fed watch tool), a half-point increase is not off the table as several Fed officials, including Minneapolis Federal Reserve President Neel Kashkari, remain undecided on a quarter or half-point rate hike in the next meeting. Bostic’s glimmer of hope boosted market sentiment on Thursday following consistently hawkish rhetoric from Fed officials in recent weeks.

Treasury yield movement last week

Following stronger-than-expected manufacturing data, the 10-year treasury yield lifted above 4% on Wednesday, the first time since November. The 2-year treasury followed suit, reaching 4.887% at market close on Wednesday. Treasuries reversed course on late Thursday, however, following Bostic’s dovish remarks, levels across the curve fell to around 3.99%. The S&P 500 and Nasdaq climbed, and the dollar retreated.

Swap rates remain at elevated levels

Swap rates continued to rise to uncomfortably high levels throughout the week following the prior week’s PCE reading and continued hawkish speak from the Fed. Companies who are contemplating hedging their interest rate risk can consider layering in tranches of their desired hedge notional over time to avoid the risk of locking in all at once. For example, if the desired total notional to swap is $400,000,000, consider hedging $100,000,000 over four different dates to smooth the impacts of market risk. Additionally, companies can consider hedging out to longer tenors, as the shape of the forward curve results in a lower swap rate that can be locked in for a 5-year tenor versus a 3-year tenor.

The week ahead

All eyes will be on Friday’s employment and unemployment report for February following the last month’s hot jobs report, which came in more than double what was forecasted. The release may determine the size of the Fed’s rate hike decision come this month’s FOMC meeting on March 21–22.