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Market Update

Strong economic data, persistent inflation sends yields higher

Date:
September 18, 2023
  • william smith headshot

    Authors

    Bill Smith

    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA

Summary

Treasury yields rose moderately across the curve last week as investors digested the latest inflation readings and awaited the rapidly approaching September FOMC monetary policy meeting.

Rates rise amid strong economic data, persistently high inflation

  • Treasury yields increased across the curve last week, returning to the over 15-year highs set in mid-August.

Portfolio Layer Method hedging activity continues

  • Although we have observed a notable rise in asset-sensitive hedging strategies recently, Portfolio Layer Method (PLM) hedging represent most of the executed hedging strategies we have seen year-to-date, and last week was no different.

Inflation remains elevated, retail sales impress

  • Market participants received several high-profile economic updates last week, including updated Consumer Price Index (CPI), Producer Price Index (PPI), and retail sales reports.

Rates rise amid strong economic data, persistently high inflation

  • Treasury yields increased across the curve last week, returning to the over 15-year highs set in mid-August.
    • The 2-year Treasury yields climbed four basis points and crossed the psychologically significant 5% level, while the 10-year yield rose a slightly more robust seven basis points to end the week at 4.33%.
    • The marginally higher moves at the long-end steepened the curve, with the 2s/10s basis now sitting roughly 30 basis points higher than levels seen in the middle of the summer.
  • Although Fed officials refrained from holding speaking engagements during the week as they respected the media blackout before the upcoming FOMC monetary policy meeting, market participants received plenty of market-moving updates with the latest inflation and retail sales reports.
    • Despite the plethora of updated data, market participants continue to expect the Fed to pause at the next meeting and refrain from altering the policy rate.
    • Interestingly, market participants still ascribe a roughly 50% probability to the FOMC raising the Target Range another 25 basis points by year-end, but expectations for when that increase will happen shifted from the November meeting to the December meeting in the last week.
    • Looking ahead to 2024—market participants currently expect the Fed to begin cutting the policy rate in Q2 2024 and slash rates approximately 75 basis points from current levels by year-end 2024.

Portfolio Layer Method hedging activity continues

  • Although we have observed a notable rise in asset-sensitive hedging strategies recently, Portfolio Layer Method (PLM) hedging represent most of the executed hedging strategies we have seen year-to-date, and last week was no different.
  • Roughly 65% of all the executed hedges crossing our balance sheet strategies this year are designed to protect against further increases in interest rates.
    • Of this cohort, most clients have opted to leverage the flexibility the PLM framework offers instead of utilizing wholesale borrowings for the hedge accounting support.
  • As noted previously, asset-sensitive hedging strategies have experienced an increase in executions and inquiries over the last month.
    • Costless collars remain the most popular product used as they can be structured without the implied negative carry associated with current receive-fixed swap transactions.

Inflation remains elevated, retail sales impress

  • Market participants received several high-profile economic updates last week, including updated Consumer Price Index (CPI), Producer Price Index (PPI), and retail sales reports.
  • According to the Commerce Department, consumer prices increased 0.6% over the last month, in line with the pre-release consensus expectation but triple the 0.2% pace observed in July.
    • The closely watched core measure, which excludes the often-volatile food and energy components, rose 0.3% since July, slightly above expectations and marginally higher than the 0.2% pace reported in July.
  • Investors reacted strongly to the monthly PPI Index on Thursday after the release indicated producer prices rose almost double the consensus estimate and reported a 0.7% increase month-over-month.
    • Although producer price gains moderated somewhat at the beginning of the year, the last two readings have significantly topped expectations and registered the two largest monthly increases since the turn of the year.
  • Thursday’s release of the August retail sales report turned the heads of market participants after the release indicated that retail purchases increased a robust 0.6% in the last month, shattering the consensus estimate for a meek 0.1% increase.
    • The substantial increase over the month was driven primarily by higher prices at the pump and strength at clothing and electronic stores.
    • Sales climbed a more modest 0.2%, excluding gas and auto purchases.

The look forward

Upcoming economic data releases

  • Housing Starts – Tuesday
  • Building Permits – Tuesday
  • MBA Mortgage Applications – Wednesday
  • Jobless Claims – Thursday
  • Philadelphia Fed Business Outlook Survey – Thursday
  • Existing Home Sales – Thursday
  • Leading Index – Thursday
  • S&P Global US Manufacturing / Services PMIs

Upcoming Federal Reserve Speakers

  • FOMC Rate Decision and Fed Chair Powell Press Conference – Wednesday
  • Cook, Daly, Kashkari – Friday

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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