Yields fall, ARRC launches “SOFR first” initiative
- June 14, 2021
Balance Sheet Risk Management
Financial Institutions | Kennett Square, PA
Prior week summary
The major U.S. equity indices ended the week mixed with the tech-heavy Nasdaq Composite Index faring the best as updates to the Consumer Price Index and infrastructure bill negotiations in Washington dominated headlines in a week with few economic data updates and a speaking engagement blackout for Federal Reserve officials. After rising considerably to start the year, the 10-year Treasury yield has drifted lower since mid-May. Last week, the move accelerated with the 10-year yield finishing the week at 1.47%, approximately nine basis points lower than the week prior. Much of the move downward was a result of a decline in inflation expectations with the 10-year breakeven inflation rate plummeting to 2.36%, down six basis points on the week. Inflation was on the minds of many market participants last week as the May Consumer Price Index reading was released on Thursday and indicated that prices increased 0.6% month over month above analyst calls for a 0.5% increase but a deceleration from the 0.8% pace seen in April. The so-called “reopening categories” accounted for much of the monthly increase with used cars, rental cars, and insurance premiums leading the charge. While the latest readings topped expectations yet again, the realized levels in May are much closer to estimates than the expectation-smashing readings seen in April. All eyes will turn to the FOMC meeting next week to see if the recent pick-up in inflation drives additional discussion between Fed officials on the timing of paring back the $120 billion per month asset purchase program or modifies the expected timeline for Fed rate hikes. Data releases for the rest of the week were light, but in a bright spot, jobless claims for the week of June 5 fell to 376,000, marking the sixth consecutive week of declines and notching a new pandemic-era low.
After House Democrats unveiled a $547 billion infrastructure proposal the week prior, a bipartisan group of Senators announced a $1.2 trillion infrastructure proposal on Thursday. The proposed bill would focus primarily on physical infrastructure with $579 billion in new spending. Notably, the plan would be paid for without increasing taxes. Early reactions from the White House were positive but White House spokesperson Andrew Bates emphasized that, “questions need to be addressed, particularly around the details of both policy and pay-fors, among other matters.” The latest proposal is one of many unveiled in the last two months as lawmakers look to find common ground, but it appears to have taken the lead after weeks-long talks between the White House and GOP lead negotiator Senator Shelley Moore Capito broke down on Tuesday. In a joint statement announcing the proposal, the bipartisan group of Senators said, “Our group — comprised of 10 Senators, five from each party — has worked in good faith and reached a bipartisan agreement on a realistic, compromise framework to modernize our nation’s infrastructure and energy technologies. This investment would be fully paid for and not include tax increases.”
With the regulator-mandated end to new U.S. dollar LIBOR transactions less than seven months away, the Alternative Reference Rates Committee (ARRC) announced a “SOFR first” initiative last week. This new initiative would require interdealer brokers to change from their current LIBOR-based pricing conventions for dollar swaps transactions to one that uses SOFR-based pricing conventions. The ARRC hopes that if interdealer brokers quote against SOFR, momentum would grow outside of the interdealer broker community and into the broader market, enhancing liquidity and laying the groundwork for a term SOFR. The CME Group announced one-month, three-month, and six-month tenor term SOFR reference rates in April but has yet to receive a formal endorsement from the Federal Reserve-backed ARRC. Tom Wipf, ARRC Chair, emphasized the importance of the “SOFR first” initiative and hinted at a possible term SOFR endorsement last week saying, “Of the things we thought were really critical to get a term SOFR, this probably stands out as the most important milestone for the market to meet. If we can arrive at a place where this ‘SOFR first’ initiative is as successful as it has been in the U.K., we won’t be very far away from the endorsement of term SOFR.”
The look forward
Market participants are looking forward to a busy week of economic data releases with updated figures on retail sales, the Empire Manufacturing Index, the Producer Price Index, industrial production, jobless claims, and the Philadelphia Fed Business Outlook Survey, among others, dotting the economic calendar. The FOMC will meet on Tuesday and Wednesday for the latest monetary policy meeting.
Market implied policy path (Overnight indexed swap rates)
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