Proceed with caution. That’s the message to take this morning in what is shaping up to be an extremely volatile session in the markets after further escalation to the never-ending Trade War involving the US versus the world. Our good and trusty southern neighbor, Mexico, is now feeling the wrath. Unlike in Greg Focker’s world, there is no longer a “circle of trust” as trade tensions continue to mount, causing extreme volatility and shockwaves throughout global markets.
Yesterday, President Trump announced a 5% tariff on all Mexican goods to take effect starting June 10 in an attempt to curb illegal immigration. The tariff penalty could increase to as much as 25% by October should the immigration problem not be curtailed.
At the same time, China has threatened to produce a list for blacklisting of foreign entities they believe do not obey market rules. This move could potentially damage the interest of domestic companies within China as retaliation against the latest US move to curb business done with Chinese tech company Huawei. It’s kind of ironic that arguably the biggest manipulator of global markets would produce a list of companies that don’t obey market rules, yet that is for a separate discussion.
Either way, when you couple the above with another reported slowdown in Chinese Manufacturing (makes one wonder who has the upper hand in the Trade negotiations) and a huge reported drop in German retail sales, the risks to the global economy are apparent. Perhaps all the volatility is warranted, paving the way for the perfect recipe leading towards a 1% handle on the 10-year Treasury, as safe haven buying around the globe has taken fresh hold of the markets. The global rally in yields has reached new, perhaps dangerous low levels with no real end in sight. The prospects of a Fed rate cut to calm markets further are now gaining more steam. Maybe a 25-50 basis point cut at this point may not be such a bad idea after all –certainly a better idea than it was when they decided to make a sequel and then trilogy to “The Never Ending Story.”
As global yields continue to rally, Fixed Income spreads are feeling the heat with credit spreads across all sectors and spectrums yielding to the greater market volatility, and perhaps taking the fun out of the low yielding environment those in our business love so much.
With Stock futures showing sharp declines this morning, yields across the Treasury curve are rallying back down to multi-year lows, particularly at the long end of the curve. At the time of this writing, the 10-year Treasury was yielding 2.15%, the lowest level seen in almost two years while the 2-year Treasury is now sub 2%, trading in at 1.99%.
When looking at the shape of the curve it is indeed a conundrum, looking ever so similar to the Verizon Wireless trademark check, with yields dipping at the belly of the curve on investor buying, perhaps further suggesting global economic weakness and the strong prospects of a recession down the road.
Be that as it may, when observing the US Treasury curve versus global yields, the spread basis versus comparable duration in some cases is truly mind-boggling. The 10-year German Bund yield, the closest comparable counterpart to the 10-year UST, is well into negative territory, yielding an astounding -0.20%. The delta versus the US 10-year is roughly 235 bps.
Comparable Japanese, Swiss, and Dutch yields are also in negative territory with some other foreign powers not that far off. Trying to understand why one would invest in a 10-year bond which only loses money from the start when you can pick up well over 200 basis points investing in a US 10 year is like trying to understand what was going through Chuck Noland’s mind when Wilson never responded to him on the deserted island.
On the Commercial Real Estate front, it remains competitive out there, but to the surprise of no one, it is volatile. While portfolio lenders may have more leeway for the time being, those of us on the securitization side keep watching ever intently the broader market pullback in spreads with CMBS, CLO’s, and Agency CMBS now following suit. Secondary and New Issue spreads in 10-year AAA CMBS is now being talked in the high 80s to low 90s range over swaps and roughly 10 bps wider than the market tights we saw a number of months ago. As Treasury yields continue to rally and AAA buyers set hard yield floors on investments, we expect spreads will widen further from here as well, down the credit curve causing wider loan level CMBS spreads, which are currently averaging anywhere from 165-225bps over the greater of Treasuries or Swaps.
Over where things really matter on the Agency CMBS end, where things are supposed to be more stable, it has been anything but. The market has taken its cue from the volatility in CDX and other larger asset classes much like the lady in the restaurant after hearing Sally, “I’ll have what she’s having.” There is no easy way to say it except that spreads in Agencies are wider across the spectrum with a majority of the volatility centered on high premium New Issue DUS as well as GNMA project loans.
While recent New Issue Freddie K’s trading in the secondary have only widened roughly 5 bps into the volatility, call A2’s swaps plus 63 bps for now, new Issue DUS has widened nearly 5-10 bps across the curve with steeper widening seen on small/high premium pieces a theme we have become accustomed to over the course of the last few months. Traditional 10/9.5 DUS are ranging anywhere from 65-80 bps over swaps depending on loan size and coupon level, and perhaps the largest disparity we have seen in quite some time.
Additionally pullback is being seen in longer duration maturities at the 20-to 30-year parts of the curve, particularly those with Interest Only, as most investors are not looking to be saddled with duration in the current yield environment. One area we are being more cautious on into the rate rally are shorter prepayment or graduated prepay structures where the pullback in spreads may become more pronounced, especially if yields continue to rally and the bonds are worth close to or at higher premium levels than the prepayment charge. As it is with every rally in yields, GNMA bonds tend to be the most sensitive. With clear yield floors in place, spreads have widened a good 10-15 bps this week alone with a majority of the widening seen at the par to $102.00 portion of the price curve, given the extraordinary low yielding coupon levels. Right now we would call the sweet spot out in the market to be a $104-$106 coupon bond with a gross note rate before MIP anywhere from 3.60 – 3.90, not too shabby. GNMA CL’s continue to trade roughly 65-75 bps wider from Project loans with the emphasis on higher/accurate first draws becoming more pronounced, and the potential repricing of already rate-locked coupons should that first draw not come close to the level disclosed at the time of the trade.
The moral here folks is that things are extremely turbulent and volatile out there now. While yields continue to rally, spreads are wider and will continue to move throughout the day. Outside of that, there is nothing else new to report. Have a productive day and a terrific weekend. Reach out if you need us.