Treasury yields rise as Fed officials call for higher rates

Treasury yields rise on Fed speak

• After declining substantially during the last several weeks amid global banking industry stress, Treasury yields advanced significantly on the back of hawkish Fed commentary last week.

Interest rate hedging continues amid pick-up in rates

• Despite the pick-up in the short end of the curve last week, hedging activity remained elevated as clients looked to fine-tune their risk positions.

Large banks experience deposit outflows, small banks see small increase

• According to the latest Federal Reserve deposit data, the U.S. banking space notched another weekly decline in deposit levels, but small banks saw inflows seasonally adjusted.

Inflation moderates, consumer confidence deteriorates

• Market participants reacted to the week’s economic releases that saw inflation moderate more than expected and consumer confidence wane.

Treasury yields rise on Fed speak

• After declining substantially during the last several weeks amid global banking industry stress, Treasury yields advanced significantly on the back of hawkish Fed commentary last week.
• The front end of the curve saw the sharpest increases as the 2-year Treasury yield rose a substantial 30 basis points during the week to 4.06%, while the 10-year yield moved a more modest ten basis points higher to 3.48%.
  • The large moves at the front end of the curve compressed the 2s/10s basis to -0.58%, settling far away from both the recent lows of -1.10% and recent highs of -0.38%.
• Fed Funds futures pricing changed materially for 2023 and early 2024 last week.
  • The market’s expectation for the policy rate in January 2024 rose over 45 basis points last week to 4.17%, with the start of the rate-cutting campaign now expected to start in September 2023 compared to July the week prior.
• Fed officials held several speaking engagements, and their hawkish commentary drove much of last week’s increases. Fed officials Collins, Williams, and Kashkari each suggested that higher rates would be appropriate in the near term.
  • Notably, Kashkari highlighted his preference for higher rates but suggested that an unknown level of credit tightening materialized after high-profile bank closures in recent weeks.

Interest rate hedging continues amid pick-up in rates

• Hedging activity increased significantly in March due to falling rates across the curve.
• Despite the pick-up in the short end of the curve last week, hedging activity remained elevated as clients looked to fine-tune their risk positions.
  • Liability-sensitive clients protecting against further increases in interest rates dominated much of the hedging activity.
  • While Portfolio Layer Method hedging against fixed-rate assets has taken the lion’s share of executions recently, wholesale borrowing hedging increased significantly last week as clients locked in the cost of new funding against an inverted curve.
• Implementation and execution of falling rate hedging strategies moderated recently compared to 2022 and early 2023 levels, with many asset-sensitive clients currently exploring these strategies, opting to use options for “disaster” insurance.
  • Rates ticking up slightly last week didn’t slow borrowers in loan-level hedging programs from looking to capitalize on rates they still view as very favorable compared to conventional fixed-rate pricing and the recent highs of the last six months.
• Borrowers with existing floating rate debt continue to push to hedge their debt rather than wait and potentially miss the current dip in market rates.
• The second quarter of 2023 seems likely to start with significantly higher borrower swap volumes than the first quarter.

Large banks experience deposit outflows, small banks see small increase

• While U.S. financial institutions have been experiencing deposit outflows for months in aggregate, outflows accelerated in the wake of several high-profile bank closures in March.
• According to the latest deposit data released by the Federal Reserve, deposits at U.S. commercial banks fell by $83.97 billion seasonally adjusted during the week ended March 22.
  • Interestingly, when excluding the 25 largest U.S. financial institutions, deposits increased week-over-week by $5.81 billion seasonally adjusted, reversing some of the significant inflows seen at the largest U.S. banks in the immediate aftermath of this month’s bank closures.
• Funding pressures appear to be normalizing in the last two weeks as wholesale borrowing issuance from the Federal Home Loan Banks and Bank Term Funding Program borrowings have stabilized in aggregate across the U.S. banking system.

Inflation moderates, consumer confidence deteriorates

• Market participants received a deluge of economic updates last week with most of the attention focused on Friday’s inflation and consumer confidence releases.
• According to the Commerce Department, the Fed-preferred measure of inflation, core PCE, increased 0.3% in February, far below the 0.6% monthly increase in January.
  • Yearly, the core measure also moderated slightly to 4.6% compared to 4.7% in January.
  • Although yields fell across the curve after the release, the February release fell roughly in line with analyst estimates and lent credence to comments from Federal Reserve officials earlier in the week that said higher rates would likely be necessary to bring inflation closer to the 2% average target.
• The University of Michigan’s preliminary March consumer confidence reading suggested that consumer confidence has waned in the face of higher interest rates and global banking industry stress.
  • According to the report, the latest consumer confidence reading snapped a three-month streak of improvement, falling to 62.0 from 67.0 in February.
  • The survey found broad-based declines in the current and expected conditions measures, while the short-term 1-year inflation expectation moderated to 3.6% from 3.8% in February.
• Lastly, according to the third and final Q4 GDP release, the U.S. economy accelerated at a 2.6% annualized pace in the fourth quarter, slightly below the previously estimated 2.7% annualized increase.
  • Looking ahead, the Atlanta Fed’s GDPNow model, which attempts to forecast the current quarter’s GDP in real-time, estimates a modestly slower pace of economic growth in the first quarter at 2.5%.

The look forward

Upcoming economic data releases

• S&P Global US Manufacturing PMI – Monday
• Construction Spending – Monday
• ISM Manufacturing Index – Monday
• Factory Orders – Tuesday
• Durable Goods Orders – Tuesday
• ADP Employment Report – Wednesday
• S&P Global US Services Index – Wednesday
• ISM Services Index – Wednesday
• Jobless Claims – Thursday
• March Non-Farm Payroll Report – Friday

Upcoming Federal Reserve Speakers

• Cook – Monday
• Cook, Mester – Tuesday
• Bullard – Thursday

Rates snapshot

Market implied policy path (overnight indexed swap rates)