Global Central Banks and the Fed were the apple of everyone’s eyes this week, spurring the major Equity Indexes to record highs, catapulting Bond Market gains back to levels not seen since 2016 here in the US and record low yields for some of our overseas friends.
The cheering could be heard miles away and kind of reminded me of Ross’s neighbors cheering for “Howard the Handyman” upon his retirement, and yes of course, to Ross he is just “Howard.” The willingness and signals from the ECB early this week that further fiscal stimulus and rates cuts are likely coming through year-end began the market rally. These signals were only eclipsed by the “dovish” FED, at least somewhat depending on how you interpret their statement released following the FOMC meeting this week.
While a July rate cut by the Fed is no sure thing, dropping the word “patient” in favor of “closely monitor/will act as appropriate” when describing future monetary policy, and replacing the word “solid” with “moderate” when painting a picture of economic growth, were both enough to convince market participants that the Fed will act soon and cut rates – perhaps as much as 50bps prior to year-end. This sent Treasury yields sharply lower, steepening the yield curve to levels not seen in almost a year, and sending the major indexes to record highs. It seems a simple game of Scrabble can have such a profound impact on the markets and makes you wonder what things would look like if the word patient was replaced with impatient or something to that effect.
All this on the notion that economic conditions are weakening and perhaps rougher times lie ahead. So yes, for the markets bad news is good news and good news is bad news. That’s just the way things will roll for the foreseeable future which is certainly confusing in of itself. So while we all may have forgotten this week that there is a Trade War taking place between the two largest world economies, the G20 Summit on tap for next week, and the President acknowledging that he and Chinese President Xi will sit down for a meeting of the minds, it will be interesting to see how the markets react.
In general, news on trade will follow the “normal” market convention of good is good and bad is bad, and a positive outcome can help steamroll Equity markets well past current levels. The question remains: what of Treasury yields? Would the impact of the Fed statement and likely cut continue to increase demand or will money start piling out of the Treasury Market and flow into Equities? After all, the money needs to come from somewhere. The same situation can be analyzed for a negative outcome. So while all eyes will be glued next week on that important meeting, for now, we can all sit back and relax, much like Mitch and Curly when herding the cattle drive through the Rockies, and enjoy the new reality of a 2% 10 year Treasury yield with all-time highs on the DOW and S&P.
This morning, market sentiment is slightly lower, mostly due to traditional profit taking after the rally. Stocks opened lower and Treasury yields remained flat to slightly higher. Yesterday saw the 10-year UST yield trade with a 1% handle for the first time since 2016 as the yield fell to as low as 1.96% before trading back higher towards the end of the day. At the time of this writing 10-year yields are clearing in the 2.03% range, with the 2-year coming in at 1.77%, and now a 26bps delta between the two closely watched Indexes.
The shape of the curve continues to do its bidding and confuse folks to no end. I continue to liken it to the picture of the Verizon Wireless symbol as 3-month Treasury yields continue to trade well north of both the 2- and 10-year Treasury yields. While wider this morning, generic swap spreads were tighter most of the week, mostly due to convexity hedging by mortgage originators taking place on the heels of the rally in yields. What remains astounding is the delta in yield between the US 10 year Treasury and our closest counterpart security the 10-year German Bund. As of this morning, the Bund was trading at a negative 0.25% yield. That’s nearly a 225bps difference between the two essentially risk-free securities. By the way, I still don’t get the concept of investing in a negative arb security – it just reminds me of any scene in “The Matrix” where I just don’t get what’s going on.
Which now brings us to our world of Commercial Real Estate Finance and is now ever a good time to lock in those low mortgage rates or what? With the rally in yields, the competition for loan assignments remains fierce despite some slight Portfolio lender widening experienced in the markets. For securitization lenders, it has been somewhat confusing (seems to be a popular word used for this update). New Issue CMBS spreads have been widening into the rally as is evident by the Credit Suisse CSAIL transaction which priced earlier this week which hit the 100bps mark over swaps and the initial talk on the Wells transaction expected to price today which is expected to clear in the high 90s range. On the heels of this CMBS loan level spreads should be wider, but with the competition so fierce we are just not seeing the comparable widening that would be expected. Or at least yet.
On the Agency CMBS front, what many would have expected would be a sharp widening in spreads into the rates rally, is currently not happening. In fact, at some points of the curve spreads are actually tighter particularly in the 10- to 30-year range with full call protection (Yield Maintenance or defeasance) as the search for yield in longer duration continues to gain steam particularly as the Treasury yield curve has steepened over the last week or so. For now, we would call FNMA DUS spreads stable to slightly tighter on the 10- to 30-year portion of the curve with 5- to 7-year structures losing the yield battle with some modest spread widening. At the same time, we continue to see tiering in loan size as DUS loans below $5M with higher premium levels continue to trade at sharply wider levels over swaps out in the market, in some cases as much as 10bps wider.
This week Freddie issued its first ever all “Green” pool, a roughly $500MM securitization which saw its 10-year bonds trade in at swaps plus 60bps and in line with market expectations and slightly wider than the latest mixed 10-year securitization, K-093, which priced last week at swaps plus 58bps. For the most part, secondary Freddie spreads in both the K shelf and on the FRESB side remained stable this week. The talk of the town has been the GNMA market. Traditionally, GNMAs are most sensitive to a lower yielding environment. That remains the case with some caveats. Given the low yields, it is nearly impossible to get a $100-$104 coupon done in today’s market, so while we are showing rates on the daily sheets for those points of the price curve, we warn ahead to act with caution. The focus of the market is anything $104 plus given the current coupon environment with Project Loans trading in the mid to high 70s over swaps in the $104-$108 portion of the curve and sharply wider for anything less, if even available.
The rally in yields has given new rise to the A7 market, where we expect volume will increase substantially in the coming months. The surprise though has come on the GNMA CL end where spreads in the $104+ coupon range have come screeching in for the right deals with strong draw schedules and normal conversion time periods. Week over week, we are nearly 20bps tighter on CL’s, even tighter in some cases, as the search for yield has spurred market demand where necessary. Definitely good news for a 221(d)(4) market which has lagged overall market performance for quite some time. The moral in general folks, lock now and lock fast.
We don’t know how long this low yielding world will last, and outside of maybe some quant genius hiding in a basement somewhere, I am not sure many of us thought we would see a 1% handle on the 10-year anytime in the near future. New reality? Perhaps. Again – lock now and lock fast.