policy tools. There are also concerns of the recent flattening yield curve ahead of potential rate hikes. What to expect: It’s Groundhog Day with even more liquidity, low loan demand, further margin compression and interest rates moving back to record-lows. “History doesn’t repeat itself, but it often rhymes.” This famous quote by Samuel Clemens (aka Mark Twain) is especially fitting today. The challenges brought on by the COVID-19 pandemic have been unprecedented, so answering the question of “what’s next” is no easy task. Exhibit 2 / Historic Yield Curves However, recent history can at least provide a framework for strategy development. For example, we know that in every case where the United States Treasury yield curve has inverted, an economic recession was soon to follow. Strangely enough, months before the very first case of COVID-19, the yield curve inverted in May 2019 (Exhibit 2). It’s entirely plausible that even if the pandemic hadn’t unfolded, a (less severe) economic downturn may have been inevitable. Most financial institutions are asset sensitive and perform better in a rising rate environment. Generally, margins increase in rising rate environments, but that depends on the shape of the yield curve. Bond yields have recently moved in a bear flattener position where interest rates have moved higher, but the difference between short- and long-term yields have compressed. In fact, 2022 began with an inverted yield curve as the 20-year treasury traded slightly higher than the 30-year long bond. January’s yield curve is also the flattest it’s been ahead of a potential Fed tightening cycle (Exhibit 2). That’s not exactly an ideal recipe for margin improvement. The chart in Exhibit 3 shows the changes in the upper bound target for the Fed Funds Rate and 10-year Treasury relative to the cost of interest-bearing deposits for members of FHLBank Topeka since 2000. The chart also highlights the Fed’s Quantitative Easing and Tapering activity. Exhibit 3 / Interest Bearing Deposits and Fed Funds Rate One takeaway is that in both the rising rate periods that began in 2004 and 2015, respectively, deposit costs didn’t reach their peak until the Fed had already reversed course and began lowering interest rates. If this trend persists as the Fed potentially increases rates this year, it could be 2023 before we see the next peak in member deposit rates. A second takeaway is the 10-year Treasury yield reaches a terminal high ahead of the peak in Fed Funds. This pricing behavior can serve as a better forward-looking indicator in the market. Unlike the prior two rising rate periods, the 10-year is well ahead of the Fed. There’s a lot to unpack here with more questions than answers for members. But now, more than ever, thoughtful preparation for multiple rate path scenarios can go a long way to mitigate these uncertainties. As always, the FHLBank Topeka team is here to help our members achieve their performance objectives and will continue to be a resource as we move forward in 2022. Drew Simmons is the Oklahoma Regional Account Manager for FHLBank Topeka. He has more than 20 years of experience in the industry. Drew studied finance at Oklahoma City University. He can be reached at 800.933.2988 or at drew.simmons@fhlbtopeka.com. Most financial institutions are asset sensitive and perform better in a rising rate environment. March • April 2022 17
RkJQdWJsaXNoZXIy MTIyNDg2OA==