Treasury yields drop, FOMC raises rates

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Treasury yields fall as contagion fears reignite

• Despite rising significantly during the first half of the week, Treasury yields dropped week-over-week as contagion fears spilled over to a large European lender on Friday and soured global banking industry sentiment.

Interest rate volatility drives hedging activity

• As yields dropped for the third consecutive week, many clients leveraged cash flow and fair value hedging strategies to protect against increases in interest rates from current levels and achieve favorable hedge accounting treatment, while current trends on the loan level hedging side intensified as rates continued to fall.

FSOC holds closed-door meeting, First Citizens Bank acquires Silicon Valley Bridge Bank

• Treasury Secretary Janet Yellen convened a closed-door FSOC meeting on Friday, while First Citizens Bank announced early Monday that they reached an agreement with the FDIC to purchase substantially all the loans, consumer deposits, and liabilities of Silicon Valley Bridge Bank.

Treasury yields fall as contagion fears reignite

• Despite rising significantly during the first half of the week, Treasury yields dropped week-over-week as contagion fears spilled over to a large European bank on Friday and soured global banking industry sentiment.
• The 2-year Treasury yield fell five basis points to 3.76%, while the 10-year yield fell a more modest one basis point to 3.38%.
• The larger declines seen at the front end of the curve compressed the 2s/10s basis slightly to -0.38%, but current levels remain far steeper than the four-decade low of -1.10% seen earlier this month.
• Despite the FOMC’s decision to raise the Target Range by 25bps to 4.75% - 5.00%, market expectations currently see last week’s hike as the final hike in a historic Fed tightening cycle.
• Fed funds futures pricing on Friday suggested market participants see just a 25% chance of another hike but a substantial probability of rate cuts this year.
• Following the FOMC’s two-day policy meeting, an updated Summary of Economic Projections release indicated that Fed officials do not expect any rate cuts in 2023, a stark contrast to the 100 basis points of 2023 rate cuts expected by the market currently.
• The divergence continues into 2024, where the median Fed official forecast places the policy rate at 4.25% at the end of 2024, compared to the market’s expectation of 2.90% in December 2024.

Interest rate volatility drives hedging activity

• Despite the significant volatility and whipsawing of interest rates in recent weeks, hedging activity has increased significantly on the back of heightened global macroeconomic uncertainty.
• As yields dropped for the third consecutive week, many clients leveraged cash flow and fair value hedging strategies to protect against increases in interest rates from current levels while achieving favorable hedge accounting treatment.
• Although many U.S. financial institutions have utilized wholesale borrowings in the hedge accounting relationship recently, more than half of the rising rate hedging strategies we have helped clients implement year-to-date have leveraged the Portfolio Layer Method against a fixed-rate asset portfolio given the increased flexibility afforded by improvements to the standard.
• Current trends on the loan-level hedging side intensified last week as rates continued to fall.
• With rates all along the curve at their lowest levels in over six months, borrowers were anxious to hedge outstanding debt and gain rate protection for future financings.
• One-month CME Term SOFR was published at 4.80% on Friday, giving borrowers with outstanding floating rate debt the ability to achieve significant immediate interest savings with a swap at virtually every point on the curve.

FSOC holds closed-door meeting, First Citizens Bank acquires Silicon Valley Bridge Bank

• Treasury Secretary Janet Yellen convened a closed-door Financial Stability Oversight Council (FSOC) meeting on Friday to discuss “current conditions in the banking sector.”
  • The closed meeting included Fed Chair Jerome Powell and the head of the FDIC, among others.
  • The council released a statement following the meeting emphasizing that “the U.S. banking system remains sound and resilient.”
• In a major market-moving event, First Citizens Bank announced on Monday morning that they reached an agreement with the FDIC to purchase substantially all the loans, consumer deposits, and liabilities of Silicon Valley Bridge Bank.
  • First Citizens Bank was successful in its bid for the troubled lender, and as a condition of the deal, will receive a line of credit from the FDIC for liquidity purposes.
  • Notably, First Citizens Bank did not purchase roughly $90 billion in securities and “other assets” as part of the acquisition.
• Markets have reacted positively to the news, with regional bank shares and the major U.S. indices moving higher in early Monday morning trading.

The look forward

Upcoming economic data releases

• Dallas Fed Manufacturing Activity Index – Monday
• Wholesale Inventories – Tuesday
• Conference Board Consumer Confidence Index – Tuesday
• Richmond Manufacturing Index – Tuesday
• MBA Mortgage Applications – Wednesday
• Jobless Claims – Thursday
• Q4 GDP (final estimate) – Thursday
• Core PCE – Friday
• Personal Income / Spending – Friday
• MNI Chicago PMI – Friday
• University of Michigan Consumer Sentiment – Friday

Upcoming Federal Reserve Speakers

• Jefferson – Monday
• Barr – Tuesday
• Dobbeck, Barr – Wednesday
• Barkin, Collins – Thursday
• Williams, Waller, Cook – Friday

Rates snapshot

Market implied policy path (overnight indexed swap rates)