Solid employment report backs market faith in Fed tightening

Continued labor market gains fuel higher yields

Interest rates rose last week, recouping declines seen in the week prior. With rates back at multi-year highs seen in the middle of September, borrowers and hedging companies face ongoing market challenges. In terms of the market drivers, hawkish Fed speeches combined with strong labor market data to push rates higher. The U.S. added 263,000 jobs during the month of September, beating market expectations; the U.S. hasn’t faced a monthly decline in job growth since December 2020. Moreover, the unemployment rate fell from 3.7% to 3.5%, nearing all-time lows.

While there is a prevailing view that the Fed will have to cut rates if and when the U.S. falls into recession, the labor market data push that timeframe further out. As such, 2-year yields rose about 20 basis points week-over-week; at the longer end of the yield curve, rates rose by an even larger amount, narrowing the erstwhile inversion between short- and long-term rates. Currently at about 3.90%, the U.S. 10-year yield still sits roughly 37 basis points below the 2-year yield.

From a hedging perspective, many corporate borrowers who hedged in recent years have sizable derivative asset positions; some companies have looked into opportunities to deploy that cash value, while others are structuring new trades around existing trades. For companies who are primarily floating, questions linger as to the best time to enter into such a volatile market; Chatham has been advising many companies to consider a strategy of averaging in hedges over time.

Crude climbs higher

After reversing its course of decline at the end of September, crude oil prices continued to rise last week, peaking around $98/bbl. OPEC+ met on October 5 and agreed to production cuts of 2 million barrels per day, representing ~2% of global supply. In their statement, the cartel sighted global economic slowdown and rising rates in the West as the reasons behind the production cuts. The White House has expressed disappointment in the move, leading the market to wonder if President Biden will continue to use the release of strategic oil reserves in order to lower prices. From a hedging perspective, the forward curve for oil continues to be somewhat backwardated, leading companies to take a fresh look at swaps vs. options strategies for hedging fuel risk.

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