USD Swaps: Grinding bull flattening rally into NFP

Bull Statue
The UST rally roared on, despite incredulity from several corners and thus likely feeding the move. NFP tomorrow could provide a does of reality.

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  • Grinding bull flattening rally into NFP

  • Framework for holistic bank capital review - Fed's Barr


     Grinding bull flattening rally into NFP

    The Treasury buying spree continued, with today’s move led by the back end. The 30y note yield is down 13bps to 3.611% while the 10y note yield is fast closing in on 3.50% - last at 3.51% or 10bps lower on the day. 2s10s is 2.8bp flatter at -74bps while 5s30s is 5.3bps flatter to -5.4bps. Equities are closing mixed (DJIA -0.56%, S&P -0.04% and Nasdaq +0.33%).


    The aggressiveness of the UST rally since Powell has raised more than a couple of eyebrows, but one source reasoned that the trend is your friend and throughout the month of November has seen buying and suggested that “I guess you should follow the trend until it doesn’t work.”


    Coupled with a loss of risk appetite from dealers going into year-end window dressing and keeping positions “close to the vest” - a source reasoned that the buying is likely an indication of asset managers “putting money to work” rather than a sea-change in Powell’s and the Fed’s hiking narrative. The market continues to discount the stickiness of inflation, a source considered, and right now USTs are “priced for perfection” as if CPI is going straight back down to 2%, which he thought is a bit “unbelievable.”


    Indeed, one trader considered that the aftermath of the Brookings speech is likely not something Powell intended as his remarks were balanced with a sobering view of how the Fed would need to keep rates restrictive and a higher terminal rate. Moreover, a source considered that the rally in USTs would be a headwind for the Fed in that the lower UST yields out the curve would feed into looser conditions rather than the necessary tightening needed to thwart inflation. Meanwhile the front end of the curve “can’t go much lower,” the source considered.  Still, with NFP tomorrow, sources see the potential of a strong jobs report stopping the rally in its tracks.


    Elsewhere, swap spreads pushed wider, with the wings outperforming the belly and the long end seeing higher than average volumes. IG new issuance is expected to grind to a halt in December, with the FOMC meeting Dec 14th the unofficial end of the supply for the year, sources judge. Around $20bn is expected for the entire month, surveys say, or under the amount that priced this week in the first three days.


    Currently, SOFR swaps 2s 3.5bps (+1.75bps), 3s -16bps (+1.125bps), 5s -25.25bps (+0.375bps), 7s -33.75bps (unch), 10s -32.5bps (+0.5bps), 20s -67.5bps (+1.625bps), 30s -70.625bps (+2.5bps).


     Framework for holistic bank capital review - Fed's Barr 

    In a speech titled “Why Bank Capital Matters” to the American Enterprise Institute, Vice Chair for Supervision Michael S. Barr today examined the framework the Fed is employing in its holistic review of capital standards.


    Barr states “Bank capital should be sufficient to enable the bank to absorb unexpected losses and continue operations through severely stressful but plausible events.”


      ” Yet translating that principle into a quantum of capital involves an estimate of what future risks will emerge and what losses banks will suffer. I'm skeptical that regulators—or bank managers—know the answers to these questions. Despite complex regulatory risk-weights, or simple leverage ratios, or the internal models used by banks, at bottom bank capital ought to be calibrated based on that humility, that skepticism. Capital provides a cushion against unexpected risks and unforeseen losses, those a humble and skeptical person might be careful to not try to predict with too much precision. Those a humble and skeptical person might guard against."


      “That is the spirit in which I am approaching the Fed's holistic review of capital standards. There is a body of empirical and theoretical research on optimal capital, which attempts to determine the level of capital that equalizes the marginal benefits of capital with the marginal costs. While the estimates vary widely, and are highly contingent on the assumptions made, the current U.S. requirements are toward the low end of the range described in most of the research literature. International comparisons also suggest strong capital requirements support banks and the U.S. economy. We have strong capital levels today, and generally higher bank capital requirements in the United States after the Dodd-Frank Act have corresponded with healthy economic growth and have supported the competitiveness of U.S. firms in the global economy.”


      “We are currently evaluating whether the supervisory stress test that is used to set capital requirements for large banks reflects an appropriately wide range of risks. In addition, we are considering the potential for stress testing to be a tool to explore different sources of financial stress and uncover channels for contagion that lead to unanticipated consequences. Using multiple scenarios or adapting the stress test in other ways to better account for the high degree of interconnectedness between banks and other financial entities could allow supervisors and banks to identify those conditions and take action to address them. And banks should continue to invest in and prioritize development of their own stress testing and scenario design capabilities, regularly run scenarios to understand the changing risk environment, and incorporate the results of these stress tests into the bank's assessment of its risks and capital needs.”


      “Stress testing and all the other aspects of capital regulation that I have discussed today will be considered as part of our holistic review. We're starting from a good place because capital today is strong. I hope to have more to say about that review early in the new year. As I have argued today, capital plays a central role in how a bank manages its risks, and capital regulation is fundamental to bank oversight. History shows the deep costs to society when bank capital is inadequate, and thus how urgent it is for the Federal Reserve to get capital regulation right. In doing so, we need to be humble about our ability, or that of bank managers or the market, to fully anticipate the risks that our financial system might face in the future.”


    For complete speech, please see link