Top-Level Takeaways
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- Upside surprises for labor market and inflation data sparked a market repricing of Fed expectations in February, sending rates sharply higher over the month.
- Heightened rate volatility on the front-end of the curve has made the job of pricing loans and time deposits, as well as hedging, much more challenging over the past year.
- Liquidity challenges within many depository institutions have sparked much greater demand for wholesale funding in recent months and increases in FHLB advances have impacted fixed income markets.
Note: The following commentary was written prior to the collapse of Silicon Valley Bank and the market turmoil that arose as a result of its failure.
In the markets versus the Fed battle, the latter was the clear victor in February.
Of course, that’s not a true characterization of actual events.
If there were “winners,” they would be the U.S. labor market and inflation, not policymakers trying to reign them in. The January jobs report, released on Feb. 3, revealed further resiliency for the current employment situation, with job growth notably outpacing expectations (517,000 versus 189,000) and the unemployment rate falling to 3.4%, the lowest since 1969.
On February 14, core CPI for January also exceeded expectations, including upward revisions to the prior month’s data. Prior to those data releases, the bond market was not fully embracing the Fed’s “higher for longer” rate guidance, with Fed funds futures pricing a sub-5% terminal rate this year and 50 basis points of rate cuts in second half of 2023.
As of March 1, the market is pricing a 5.40% terminal funds rate, approximately 50 basis points higher than the beginning of the month, and pricing for Fed easing in late 2023 and 2024 was largely reversed as well. This repricing of Fed expectations was the main culprit for the 56- to 63-basis-point-increase in front-end Treasury yields (2-year to 5-year) over the month.
The bond market shift was not limited to rates in February. Rate volatility, both realized and implied, turned higher again, and fixed income spreads were generally wider. If nothing else, the past four weeks were a reminder of outstanding economic and monetary policy uncertainty, and as we noted to start the year, rate volatility remains a major theme for 2023, even if “peak vol” is truly behind us. A downside surprise for upcoming employment and inflation reports would likely spark yet another market reversal, presenting risk of further realized volatility for short- and intermediate-term rates.
This market commentary is provided by ALM First Financial Advisors, LLC, the investment advisor for Trust for Credit Unions. Visit trustcu.com to read about the latest economic data and overall market trends.
Jason Haley is ALM First’s chief investment officer, joining the firm in 2008. He heads ALM First’s Investment Management Group (IMG) and is portfolio manager for the Trust for Credit Unions mutual funds. Haley and his team are responsible for leading the investment process and investment theme development for the firm. Haley also oversees all capital markets activities, including portfolio management, trading, market research and commentary, and execution of hedging and funding strategies for the firm’s depository clients. He holds an MBA with a concentration in finance and a BBA with a concentration in marketing, both from The University of Mississippi.