Why is it that whenever October rolls around, market volatility increases tenfold? There is just something about this month where global uncertainty repeatedly grips the market. Dating back to 1950, no month has seen more 1% daily swings in the market than October. Well, in keeping with the tradition, that is precisely what we are experiencing in October 2018.
Global Equities have been hit by a freight train and seemingly feel like they have been in complete meltdown mode the last few days, while interest rates – one of the main catalysts of all the volatility – just don’t know where to turn. Since last Wednesday the major indexes have dropped over 6.5% in value, with the NASDAQ suffering the most and an over 8.5% drop. The decline in technology companies has been a major harbinger of the latest market volatility.
Just a little over a week ago, we were discussing the complete opposite, with markets forging full steam ahead and everyone’s 401k enjoying the ride. Well, much like Daniel Larusso’s “wax on, wax off” karate exercise, we are very much “risk on, risk off” in today’s markets. If you are a nervous Nellie like me and are always looking at your 401k, you may want to do so with a tub of antacids by your side. As noted above, the main catalyst has been the movement in Interest Rates, with Treasury yields reaching their highest levels in over six years. The fear now is that perhaps the market is simply still not ready for higher interest rates, and the potential effects higher rates will have on a slowdown of the domestic and global economies.
In addition, Trade War rhetoric was once again front and center yesterday as the war of words between the US and China on “who is stiffing who” has made its way back into focus. This morning though we seem to have hit a reprieve in the volatility, with Equity Futures pointing to a sharply higher open, at least for now, on the heels of reports of strong trade data coming out of Beijing; 3rd quarter results from JP Morgan coming out in line with expectations; and reports that members of the US Treasury have concluded that China is not manipulating its currency despite accusations from the Trump administration stating otherwise.
Overall Market Outlook
With the positive momentum this morning in Equities, Treasury yields are trading higher this morning, with the 10-Year Treasury yield hovering in the 3.16% range, up 3bps from yesterday’s close, although still down 9bps from the three year high of 3.25% we experienced earlier in the week.
The 2-10 year yield basis is currently sitting at around 30bps and slightly flatter from where we were earlier in the week. We do expect that volatility in the Treasury curve will continue over the next few weeks, especially as the markets sort out whether a higher interest rate environment is something that can be maintained from a growth perspective and as Equity markets react accordingly.
What Does This Mean for Our Industry?
On the Commercial Real Estate Finance end, the latest market volatility is currently taking its toll as higher interest rates may be bearing down on lender pipelines with discretionary refinance opportunities for the most part taking a breather. Maturing loans, as well as acquisitions, now have to be underwritten assuming higher interest rates and the potential reduction in loan dollars on many loans from initial application levels just to maintain minimum required debt service coverage ratios.
Nonetheless, the new issue Agency CMBS market was active this week, with spreads wider on a week-over-week basis given the volatility. Fannie Mae DUS spreads were wider by roughly 4bps on the week with vanilla 10/9.5 structures now trading hands in the high 50’s over swaps, up from the mid 50’s level seen earlier this week while the ever-popular 12/11.5 structure has seen its spread go from high 60’s last week down to low/mid 60’s earlier this week and then right back up to high 60’s over the last few days. Investors of FNMA DUS paper clearly like the higher-yielding coupons and may be married to a 3.20% plus on the 10-Year Treasury as spreads seem to ebb and rise as Treasury yields move throughout the day.
Freddie Mac secondary spreads were wider this week as well, with recent K issuance A2 bonds trading hands in the swaps plus 53bps range and up 2-3bps from the previous week. Yesterday, Freddie also priced its most recent Small Balance securitization, FRESB-SB54, with spread levels clearing mostly in line with expectations.
Spreads on GNMA Project loans were also wider this week on the heels of all the market volatility after numerous weeks of spread compression as Treasury yields drifted higher and more into an investor and REMIC friendly comfort zone. GNMA PL’s are clearing in the swaps plus 47bps range for loans falling within the belly of the price curve, call it $102-$104, with not much of a difference anymore for pools at or closer to par. CMBS issuers were busy this week with one multi-borrower deal pricing in the market, that from Wells Fargo, and two deals now being marketed. The Wells deal saw its 10-year average life AAA clear at swaps +84bps. Spread guidance on the two other deals being marketed, one from Deutsche Bank and Goldman Sachs and the other from Morgan Stanley, are showing a divergence in the market as the DB Goldman deal is being shopped 6bps points tighter than the Wells deal, while the Morgan guidance is in line with Wells on perceived weakness in collateral quality and a majority of the originations coming from second-tier lenders.