I guess folks are wondering if we are out of the woods yet. After all we just experienced three straight days of relative gains on the major Equity Indices. It kind of makes you wonder if the market angels have come to the rescue upon hearing the bell ring because like Zuzu Bailey likes to say, “Teacher says, every time a bell rings an angel gets his wings.”
Maybe it’s not quite like that. However, there was a sense of “relative calm” in the market the last few days, at least on the Equity and Treasury side, which certainly can give rise to some hope at this auspicious and joyous time of year. By the way, top five Holiday movies in this Sabbath-observing, kosher eating, balding Jewish guy’s opinion:
1. It’s a Wonderful Life.
2. Miracle on 34th Street (1947).
3. Christmas Vacation.
4. A Christmas Story.
5. Home Alone.
Feel free to send me yours so we can argue.
Either way, we are not sure if “calm” has been restored but there has been a general sense that the large market swings we became accustomed to over the course of the last few weeks may have taken a breather with renewed optimism on trade between the US and China now taking center stage – particularly after China announced overnight that they would be removing the 25% tariff on automobiles imported from the US for three months in a goodwill effort to defuse trade tensions.
At the same time, global economic growth concerns are weighing heavily on the hearts and minds of investors. Data out of China continues to suggest a slowdown in the world’s second-largest economy. Comments by European Central Bank President Mario Draghi state that economic risks are moving to the downside following some uninspiring results from a slew of manufacturing reports in Europe. All this lies in the face of next week’s FOMC meeting scheduled for Tuesday and Wednesday, whereas of now the market is pricing in a 74% probability that the Fed will raise short-term rates by an additional 25bps – thereby placing further pressure on an already fragile Yield Curve which at this point is shaped more like an unwanted slug showing up on your doorstep on a dreary rainy morning.
Also, let’s not forget the potential for a Government Shutdown next week on border security. While up until now that has not really played much of a catalyst in the market volatility, as we get closer to the showdown between the President and leading Democrats, it is more than likely markets will begin to react accordingly. So if you are reading this scratching your head and wondering what to make of the current state of the markets, you are not alone. To quote Chandler Bing, right now “I’m not so good with the advice. Can I interest you in a sarcastic comment?” In short, we are just as puzzled as anybody else.
This morning the latest report on Retail Sales came in slightly better than expected perhaps alleviating concerns of a domestic slowdown, however, the market is waiting to digest reports on Industrial Production and Manufacturing, both due later this morning. If slowing growth worries are a concern, these reports should lend further insight as to the actual state of the domestic economy.
The Latest Reports
As of the writing of this commentary, the 10-year Treasury was trading at 2.89%, down 2bps from Thursday’s close as safe-haven money has flown back into Treasuries following the weak economic reports released out of China and Europe noted above.
Stock futures are currently pointing lower with global growth concerns overshadowing the goodwill gesture presented by China on Trade. After weeks of flattening – and even inversion at some points of the curve – we have seen some slight steepening over the last few days with the delta between the 2- and 10-year Treasury yields now at 15bps up from a low of 10bps earlier this week.
The 2- to 5-year basis remains inverted with the 2-year yield trading at 2.74% versus 2.73% on the 5-year. With the Fed on deck for next week and the expectation they will, in fact, raise short-term rates at least one more time we expect a further flattening of the curve as the march to a 2- to 10-year inversion may take center stage as early as next week.
What Does This Mean for Commercial Real Estate?
There is a whole lot to say about the current state of the Commercial Real Estate markets. However, like I always do, I am going to keep it brief. While the competitive landscape remains fierce between securitized and balance sheet lenders, with the recent market volatility loan spreads are wider across the sector. Balance sheet lenders have been responsive to the secondary spread widening in the CMBS and CLO markets and for the most part, have adjusted accordingly. On the CMBS end, New Issue 10-year AAA spreads are now being talked in the 105-110 range, which are the widest levels of the year and roughly 25-30bps wider than where the market had found firm footing earlier in the year.
Over here in the world of Agency CMBS it’s the same story that we have been repeating for quite some time. The overall market volatility coupled with the tremendous increase in volume all hitting the market at once has placed an enormous amount of pressure on spreads across DUS, Freddie K/FRESB, and GNMA Project/Construction loans. This week alone we saw four New Issue Freddie Mac deals price in the market totaling roughly $2.5B. Add to that approximately $1B+ in New Issue DUS and a fair amount of GNMA’s, and you could say that the market has had a full week. On the DUS side, we continue to see investors choosing their spots with no real predictability on where spreads may fall on individual transactions. Small Balance deals below $5M with higher premiums are getting hit pretty hard in the market with spreads over swaps trading anywhere from 4-8bps wider than “generic” market levels.
GNMA spreads continue to be turbulent reacting to Treasury yields staying within the 3% mark as investors continue to slap floor coupons while pricing par and low premium deals at wider spread levels. In essence, there is nothing new from what has been previously mentioned over the last number of weeks. In these uncertain times, the key sell to our clients’ needs to be the Gross Note rate. Spreads are too unpredictable and are an ever-changing trend, even intraday. With the 10-year sub 3% for the last two weeks, we should be selling that fact and do our very best to get our borrowers to lock up their deals ASAP as Treasury yields can quickly turn the other way in a heartbeat. We understand the frustration in spreads but the way I try to view it is If I were a borrower would I rather lock a rate of 5.25% with a 235bps spread or a rate of 5.35% with a +215bps spread?