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Market Update

Treasury yields rise to end Q3

Date:
October 3, 2022
  • william smith headshot

    Authors

    Bill Smith

    Associate Director
    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA

Summary

In a week of heightened volatility, Treasury yields, particularly at the long end, moved moderately higher as market participants endured a busy week digesting commentary from a slew of Federal Reserve officials, the U.K. central bank’s emergency intervention in the U.K. Gilt market, and the latest updates from a robust economic calendar.

Interest rates

  • Treasury yields ended the week modestly higher but traded in a wide range over the course of the week.
    • The 10-year Treasury yield dipped as low as 3.68% and touched as high as 4.01% but ended the week approximately 14 basis points higher than a week earlier at 3.83%.
    • Despite also seeing significant intraday swings, the short end of the curve ended the week mostly unchanged with the 2-year Treasury yield rising two basis points to 4.22%.
  • Looking at the curve’s steepness since last week, the 2s/10s basis bounced off a two-decade low and steepened modestly to -0.39%.
  • Many Federal Reserve officials held speaking engagements last week and all reiterated the Fed’s commitment to fighting inflation and restoring price stability.
    • St. Louis Fed President and Fed hawk James Bullard lent credence to the market’s strong repricing of Treasury yields following the most recent FOMC meeting saying the Fed’s resolute commitment to restoring price stability “was digested by markets and does seem to be the right interpretation.”
    • The updated dot plot forecasts an additional 1.25% of interest rate hikes by the year’s end and matches the market’s current expectations which see both a 75% chance of a 75 basis point hike at the November meeting and 1.25% of total rate increases by the end of the fourth quarter.
    • With roughly one month until the next FOMC meeting, incoming data, particularly related to the employment and inflation outlooks, will be monitored very closely by market participants and have the potential to shift expectations for how the Fed reacts in the near term.
  • Finally, real yields have moved notably higher with the 5-year real yield and the 10-year real yield rising 34 and 36 basis points higher last week, respectively.

Trading commentary

  • A week of elevated volatility and significant rate moves brought with it a week of robust hedging activity.
  • As we head into the fourth quarter, many of the same themes that were present in Q1 and Q2 were present still in Q3.
    • While hedging activity is certainly up this year across the board, the lion’s share of activity has been centered around strategies that are designed to protect against a downturn in interest rates and to preserve recent net interest margin expansion.
    • Although clients have used a mix of derivative products to achieve their risk objectives, most clients have opted to use plain vanilla interest rate swaps to hedge their downward rate risk.
  • With inflation proving persistent and the Fed continuing to hike interest rates, we have seen a pickup in strategies designed to protect against further increases in interest rates.
    • Despite elevated deposit levels in aggregate across the banking space, we have started to hear from the clients that deposit pricing battles are beginning and that wholesale funding has been of increasing importance in recent weeks.
    • To that end, we have seen clients look to the liability side of the balance sheet and implement hedging strategies that lock in or cap the cost of wholesale funding.
    • Others, however, have opted to achieve a very similar economic objective by looking to the asset side of the balance sheet and using the flexibility afforded by the recent improvements to the fair value hedging framework to shorten the duration of the fixed rate asset portfolio and increase asset sensitivity.

Bank M&A slows in 2022

  • M&A deals in the banking space have cooled significantly in 2022 thus far.
    • According to S&P Capital IQ, just 37 deals were announced in the third quarter, a steep drop from the 61 deals seen in the third quarter of 2021.
    • M&A activity for full year 2022 also looks headed for a markedly worse year than 2021.
      • With just one quarter left in the year, 123 deals have been announced though the third quarter, far shy of the 206 deals completed in 2021.
  • Nonetheless, the second biggest deal of the year by transaction value was announced last week.
    • Provident Financial Services Inc. and Lakeland Bancorp Inc. announced a $1.25 billion merger on Tuesday.
    • Pending regulatory approval, the deal is expected to close in the second quarter of 2023.

Economic data

  • After a light week of updates the week prior, market participants were the beneficiaries of a deluge of economic data updates last week.
  • The manufacturing outlook remains cloudy, but the industry appears to be slowing.
    • The Chicago and Dallas Fed manufacturing indices each fell below both the consensus estimate and the levels seen a month earlier as new orders waned, and production slowed.
    • The Richmond Fed Manufacturing Index offered a shining light for the manufacturing industry defying calls for a decline and instead gaining substantially.
  • Consumer confidence appears to have built on the momentum from a month earlier and continued to improve.
    • The Conference Board Consumer Confidence Index performed well above analysts’ expectations and notched its highest level since April.
      • Analysts pointed to the strong labor market and easing energy prices as drivers of improved confidence.
      • Most notably, consumers’ expectations for the six-month outlook improved to the highest level since February.
  • Finally, the Fed’s preferred measure of inflation, core PCE, topped analysts’ expectations as prices rose 4.7% annualized in the second quarter.

The look forward

  • Upcoming economic data releases
    • S&P Global Manufacturing PMI – Monday
    • ISM Manufacturing Index – Monday
    • Factory Orders – Tuesday
    • Durable Goods Orders – Tuesday
    • ADP Employment Report – Wednesday
    • S&P Global Services / Composite PMI – Wednesday
    • Jobless Claims – Thursday
    • Wholesale Inventories – Friday
    • September Non-Farm Payroll Report - Friday
  • Upcoming Federal Reserve Speakers
    • Bostic, Williams – Monday
    • Logan, Williams, Mester, Jefferson, Daly – Tuesday
    • Bostic – Wednesday
    • Evans, Cook, Waller, Mester – Thursday
    • Williams, Bostic - Friday

Rates Snapshot

Rates Snapshot 10 03 22

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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