If you are like me, aside for being a nervous Nellie when it comes to experiencing any sort of extreme market volatility, you are probably just trying to keep your head above water while attempting to figure out all the problems facing global markets.
And, if you are an even better person, you are trying to see what you can do to help. Well, as Harry Flugelman would say the answer to that is “Nothing, zero, zip.” (A bit more obscure than my last Three Amigos reference, sure.) From Trade War angst to further indications of slowing global economic growth, all the way to protests in Hong Kong and political upheaval in Argentina, the markets certainly gave us its fair share of issues this week.
While I wouldn’t go so far to describe it as Dr. Peter Venkman would – “Human sacrifice! Dogs and cats living together? Mass Hysteria!” – the bottom line is the volatility in the markets the last few weeks has been extensive with out of whack swings in Equities spurring a Global Bond Market rally like no other as the chase for yield and duration captivates the Fixed Income world.
Much like Lt. Daniel Kaffee we all just want answers, though we may not be entitled answers. While the markets will continue to be swayed by the increase in trade rhetoric between the US and China, the truth is as markets focus in on the dispute, all other economic factors aside, it really doesn’t take much to cause some major one-off swings in the markets. Something as simple and ridiculous as a tweet from the Commander in Chief stating he loves kung pao chicken has the potential to cause a one day 700 point rally in the DOW while sending Treasury yields sharply higher.
Nonetheless, if the Fixed Income markets are telling us anything of late, it’s that the global economic slowdown is picking up steam. As global yields continue to rally to unprecedented lows and yield curves just about everywhere invert, a clear message is being sent to Global Central Banks, specifically the Fed, that fears of a global recession are real and we need you folks out there setting monetary policy to just do something about it. The problem is, despite the recent volatility and the 6-7% downturn in the major Equity Indexes from the highs last month, from a domestic perspective, aside for the inversion of the yield curve, nothing out there is pointing to a recession and slowdown here in the motherland. As the President would say, everything here at home seems to be “fantastic.”
Not sure one can really argue with that given the positive vibe coming out of the majority of the data released on Jobs, Retail Sales, GDP, manufacturing etc. over the last number of months. So we ponder, much like Screech Powers performing a highly sophisticated Zack Morris scheme against Mr. Belding, why is the US Treasury curve rallying to unprecedented lows specifically at the longer end of the curve?
I mean a sub 2% 30-year long bond, and the first time the tenure has ever met the 1% handle should be concerning to most, no? What about 10-year Treasuries flirting with sub 1.50% with talk of 1.00% in sight well before we see a 2% handle again, all the while the 2-year Treasury yield trades right on top of the 10-year level?
While to many this may be as puzzling as trying to figure out how exactly the Ravens know where and to who to deliver a message to when flying across the Narrow Sea or to Winterfell. One really doesn’t need to delve so deep and simply needs to look to global yields across the Ocean. For many, including Germany, France, Japan, Switzerland, etc., yields are well into negative territory and are inside of any previous historic lows all spurred by the many indicators of slowing economic growth in those countries and beyond. Even with US 10-year Treasury yielding in the 1.50% range that is still an astounding +225bps delta versus what would be “received” when placing ones money in a 10-year German Bund and 177bps higher when buying a 10-year Japanese Government security. So while, yes there may be fears of a contagion factor here in the US and the inversion of the yield curve is clearly signaling that, the rally we are seeing, trade angst aside, may simply be a chase for yield and duration in the Global environment, simple because it is safe and there is nowhere else to go.
This morning Stocks are opening higher, seeking to end what has been a volatile week on a somewhat positive note. Treasury yields are trading higher from yesterdays close with the 2-, 10-, and 30-year Treasuries yielding 1.52%, 1.55%, and 1.99% respectively. That 1.99% print on the 30 is accurate and alarming but consistent with the chase for duration and yield we are seeing in the market.
On the Commercial Real Estate finance side where do we begin? The elephant in the room is clearly the recent pullback in pricing and credit by FNMA and Freddie Mac. While to many it appears the two agencies have put up a sign stating they are closed for business for the remainder of the year (allowing us to now sit back and enjoy the much anticipated 90210 reboot, which in admittedly watching and enjoying the first episode only reminded me of my teenage crush on Jenny Garth), the bottom line is they simply don’t have much of a choice. Both Agencies are well ahead of pace in terms of business booked and expected to be booked under the FHFA volume cap.
In addition with the rally in Treasury yields the volume coming in has been at a record pace, and despite a majority of the business being excluded from the $35 billion FHFA volume cap, the Agencies market share seems to be growing beyond any limits the regulator would ever be comfortable with. Not to mention the fact that we still don’t know what the scorecard will look like for 2020 and beyond, and the feeling is there may be some subtle changes particularly to Green and AMI exclusions in certain markets. With each relay message we provide from the Agencies that pricing is going up and credit is tightening further, the response from many may be similar to “You’re killing me Smalls!” yet we need to understand the Agencies have no choice and need to slow things down and curtail production by any means necessary.
While this should provide an opportunity for other financing outlets to scoop some Agency quality multifamily business, the bottom line is with the rally in yields financing spreads across the spectrum should widen, perhaps potentially in line with where pricing coming from the Agencies is currently shaking out. Should that happen and the run for Agency debt continues, we can likely expect further pricing increases from now through year end.
On the market side, both CMBS and Agency CMBS spreads have been a victim of the overall market volatility and have widened into the yield rally. On the CMBS end recent new issue AAA LCF bonds have widened 10-15bps over the last few weeks with those bonds depending on shelf now clearing in the mid- to high-90s over swaps. With a heavy load scheduled for the New Issue calendar over the coming weeks and months, and given the lower yield environment, it will be interesting to see where spreads go from here. Our expectation is wider, which should further impact new loan pricing at the CMBS loan level. On the Agency CMBS front, despite the pullback from the agencies, supply has not waned at all. In fact, it has only gotten fiercer and is coming in at a record pace as borrowers look to lock in at current yield levels. This, coupled with the overall market volatility and the rally in Treasury yields, has placed a tremendous amount of pressure on investor spreads. At this point, we would call FNMA DUS about 10-15bps wider across the curve over the last few weeks with 10/9.5 spreads over swaps trading in the low to mid 70s and closer to 80bps for deals below $3M and at higher premium levels. On the Freddie Mac end this week they priced their latest 10-year Fixed Rate transaction K96 as well as their most recent Small Balance securitization, SB65. Both deals, while wider than previous transactions, for all intent purposes priced decently into the market volatility. Pricing GNMA bonds continues to be a challenge in this market. Coupon and yield levels are simply too low, causing many market players to impose coupon floors on deals, much to the chargrin of many lenders. While at the same time the “higher” premium coupons in the 108-110 range will command a higher yield as investors grapple with paying those premiums while structuring prepays that decline starting year one at 10%. The alternative perhaps would be more prohibitive prepay structures for a lower coupon, something we are not sure many borrowers will take. Then again, given where rates currently are, if you are a long term hold borrower, you need to ask yourself, they can’t go any lower right? Very similar to the questions asked in 2011-2012.
That’s all from us for now. As has been the case all week please treat all levels as subject to the minute given the overall market volatility. Together we shall endure. Have a profitable day and an even better weekend!