Treasury yields increase despite cool inflation prints

Treasury yields rise week-over-week despite falling in the wake of inflation reports

• Treasury yields increased last week as Federal Reserve officials’ hawkish commentary weighed against downward surprises to two high-profile inflation readings.

Falling yields post-PPI drive hedging activity

• While many previously noted themes remained intact last week, we saw significantly elevated hedging activity in the wake of the Consumer Price Index (CPI) and Producer Price Index (PPI) readings that indicated elevated but moderating price pressures.

U.S. banks bolster liquidity position in Q1

• As deposit competition intensified and deposit outflows accelerated in the first quarter, U.S. banks bolstered their liquidity positions with alternative funding sources.

Inflation eases, consumer sentiment deteriorates

• Although inflation appears to be easing, consumer sentiment deteriorated on elevated long-term inflation expectations.

Treasury yields rise week-over-week despite falling in the wake of inflation reports

• Treasury yields increased last week as Federal Reserve officials’ hawkish commentary weighed against downward surprises to two high-profile inflation readings.
  • The 2-year Treasury yield ended the week six basis points higher at 3.98%, while the 10-year yield rose a more modest two basis points to 3.46%
  • The more significant increases at the short end drove the 2s/10s basis roughly five basis points lower to -0.53%, far above the multi-decade lows seen in early March but slightly below the yearly average of -0.45%.
• Federal Reserve officials held several speaking engagements last week.
  • Unlike the market’s current expectation, most officials suggested that the policy rate would need to remain near current levels in the near term to bring inflation back toward the Fed’s 2% average target.
  • Although the market expectations and the Fed dot plot suggest that the policy rate has peaked, Fed Governor Michelle Bowman suggested that additional tightening could be necessary “should inflation remain high and the labor market remain tight.”
• Looking at Fed Funds futures pricing at the close on Friday, market participants expect the FOMC’s cutting campaign to commence at the late September FOMC meeting.
  • A series of cuts are expected in the next year, with current market pricing suggesting the policy rate will end January approximately 100 basis points below current levels.

Falling yields post-PPI drive hedging activity

• While many previously noted themes remained intact last week, we saw significantly elevated hedging activity in the wake of the Consumer Price Index (CPI) and Producer Price Index (PPI) readings that indicated elevated but moderating price pressures.
• Liability-sensitive institutions hedging against further increases in interest rates drove nearly all of last week’s hedging activity as these clients looked to lock in the lowest rates since early April.
  • Although wholesale borrowing hedging activity has increased significantly since the turn of the year, last week, we saw a balanced mix of clients utilizing fixed-rate assets under the Portfolio Layer Method and others using wholesale borrowings in the hedge accounting relationship.
• The decline in term rates, coupled with the increase in overnight rates, has increased the attractiveness of these strategies in recent weeks.
  • A 3-year pay-fixed swap transaction currently offers approximately 160 basis points of initial positive carry.

U.S. banks bolster liquidity position in Q1

• As deposit competition intensified and deposit outflows accelerated in the first quarter, U.S. banks bolstered their liquidity positions with alternative funding sources.
  • According to an analysis conducted by S&P Capital IQ, non-brokered deposits fell 3.4%, in aggregate, in the first quarter, while brokered deposits increased a robust 15.3% sequentially.
  • The increase in brokered deposits marks the third consecutive double-digit sequential increase, highlighting the intense competition for deposits banks have experienced in the wake of a historic Fed tightening campaign.
• The latest data underscores the trend we have observed on our desk for several months – a marked increase in wholesale borrowing hedging activity.

Inflation eases, consumer sentiment deteriorates

• Inflation appears to be easing slightly.
  • According to the Labor Department, the Consumer Price Index decelerated to a 4.9% yearly pace in April, below last month’s 5% reading and the 5% consensus expectation.
  • Notably, housing and services prices, which have been key drivers of inflation in recent months, slowed in April, reinforcing the belief that price pressures are experiencing widespread easing.
  • Similarly, PPI decelerated in April to a 2.3% annualized pace, far below the 2.7% reading seen in March.
• According to the preliminary University of Michigan consumer sentiment report, consumer sentiment deteriorated to a six-month low in May.
  • Despite easing price pressures, long-term inflation expectations climbed unexpectedly to a 3.2% annualized rate, the highest reading in 12 years.
  • Consumers’ expectations for the future fell sharply in May as consumers’ recessionary fears coupled with the debt ceiling standoff in Washington drove sentiment lower.

The look forward

Upcoming economic data releases

• Empire Manufacturing Index – Monday
• Retail Sales – Tuesday
• Industrial Production – Tuesday
• MBA Mortgage Applications – Wednesday
• Housing Starts – Wednesday
• Building Permits – Wednesday
• Jobless Claims – Thursday
• Philadelphia Fed Business Outlook Survey – Thursday
• Existing Home Sales – Thursday
• Leading Index – Thursday

Upcoming Federal Reserve Speakers

• Bostic, Goolsbee, Kashkari, Cook – Monday
• Mester, Barr, Williams, Goolsbee, Logan, Bostic – Tuesday
• Jefferson, Barr, Logan – Thursday
• Powell, Bernanke, Williams, Bowman – Friday

Rates snapshot

Market implied policy path (overnight indexed swap rates)