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Market Update

Treasury curve steepens, housing data disappoints

Date:
October 24, 2022
  • william smith headshot

    Authors

    Bill Smith

    Associate Director
    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA

Summary

Treasury yields advanced across the curve last week as market participants recalibrated their bets for Fed policy action on the back of weak economic data and mixed comments from Federal Reserve officials.

Interest rates

  • Although interest rates pulled back on Friday, particularly in the short and mid-term part of the curve, Treasury yields saw sizeable weekly increases.
    • Notably, the 10-year Treasury yield topped 4.33% early on Friday, a 14-year high, before falling 12 basis points to end the week at 4.21%.
    • Despite the short end of the curve also rising last week, the curve steepened significantly, pushing the 2s/10s basis to its widest level since early September.
  • The policy-sensitive 2-year Treasury yield oscillated significantly during the week as a slew of Federal Reserve officials weighed in on the economic and rate outlooks.
    • Commentary early in the week was generally hawkish, with Fed officials Kashkari, Bullard, and Harker all advocating for continued, aggressive tightening.
    • The mood shifted after the WSJ reported on Friday that Fed officials are actively considering dialing back the magnitude of interest rate increases starting at the December policy meeting.
      • Short-term rates plummeted after the article’s publication, sending the 2-year Treasury yield 13 basis points lower to 4.49%.
  • Looking at Federal Funds futures market pricing on Friday, expectations for the next FOMC meeting remain essentially unchanged, but expectations for early 2023 changed materially week-over-week.
    • Specifically, market participants now see an additional 1.75% of rate hikes from current levels by the end of the first quarter, 25 basis points less than the week prior.

Trading commentary

  • Hedging activity has continued at a robust pace through the beginning of the fourth quarter, and last week we saw a continuation of the most popular themes.
  • Strategies designed to protect net interest margin from declining interest rates have taken the lion’s share of hedging activity crossing our balance sheet strategies desk.
    • With the rise in the absolute level of rates and the market’s expectation for continued and significant increases to the Target Range, zero-cost collar strategies have seen a notable rise in popularity as collar “bands” have widened recently, offering clients more upside for the same level of downrate protection.
    • Nonetheless, plain vanilla receive-fixed interest rate swaps remain the most popular vehicle for hedging exposure to falling rates primarily due to their structural simplicity and economic efficiency in hedging interest rate risk.
  • While hedging activity geared toward protecting against further increases in interest rates has slowed in recent weeks, we continue to see clients explore and execute strategies that manage rising-rate OCI risk directly.
    • Specifically, these clients often look to either variable-rate wholesale borrowings or fixed-rate AFS securities to satisfy the favorable and geographically-desired hedge accounting treatment requirements.

Big banks forecast continued NIM expansion

  • Third quarter earnings season is now well underway, and many of the largest U.S. financial institutions have reported earnings.
  • Bank of America and KeyBank forecasted robust NIM expansion through the end of 2022 and into 2023, citing the benefits of continued Federal Reserve tightening and better-than-expected loan growth.
    • KeyBank CFO Donald Kimble commented that the bank’s receive-fixed swap portfolio has limited some of the growth they have seen in commercial loan yields so far but highlighted that the program “was intentional on our part to have more of a long-term focus as far as how we manage interest rate risk,” and that, “we think that we’ll be recouping that throughout the later periods of ’23 and ’24.”

Economic data

  • Despite the lack of a major economic data releases last week, market participants were the beneficiaries of a slew of financial updates.
    • The manufacturing industry outlook worsened after the Empire Manufacturing Index and the Philadelphia Fed Business Outlook Survey dipped further into contractionary territory and performed far worse than the consensus estimates.
    • In a bright spot, industrial production reportedly improved in September, increasing 0.4% over the month.
  • The steep and substantial rise of interest rates is beginning to show up in the housing market data.
    • Housing starts and existing home sales declined notably in September from the levels seen a month earlier.
    • Mortgage applications have been steadily declining for much of the year and last week was no different.
      • Mortgage applications declined 4.5% for the week ended October 14th, the fourth straight weekly decline.

The look forward

  • Upcoming economic data releases
    • Chicago Fed National Activity Index – Monday
    • S&P Global Manufacturing / Services PMI – Monday
    • Conference Board Consumer Confidence Index – Tuesday
    • Richmond Fed Manufacturing Index – Tuesday
    • Wholesale Inventories – Wednesday
    • New Home Sales – Wednesday
    • Third quarter GDP (1st estimate) – Thursday
    • Durable Goods Orders – Thursday
    • Core PCE – Thursday
    • Jobless Claims – Thursday
    • Personal Income / Spending – Friday
    • University of Michigan Consumer Sentiment Index - Friday
  • Upcoming Federal Reserve Speakers
    • Waller – Tuesday

Rates snapshot

Market implied policy path (overnight indexed swap rates)

Market implied policy path (overnight indexed swap rates)

Market Implied Policy Path

Source: Chatham Financial

About the author

  • Bill Smith

    Associate Director
    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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