For many of us, today is arguably our most favorite Friday of the year. After all, we have reached Memorial Day weekend and the unofficial start of summer. Yup, the smell of swimming pools, beach houses, summer relaxation, and a nice barbecue are in the air, while Carvel sells out every Cookie Puss cake available.
Yet, that raging cloud of market volatility and political turmoil in DC continues to hover over us, much like the Skipper being suspended over Gilligan in every episode. Suffice to say it’s once again ugly out there, and the main catalyst of it all is, of course, Trade. With the fallout in negotiations and the harsh rhetoric between the US and China growing stronger each day, the markets are finding difficulty in the face of adversity having been sent in an utter tailspin.
Sure, some days are better than others where a glimmer of hope may rally markets. However, for the most part over the last two weeks, the index of volatility across global markets continues to rise, sending most investors into the haven of Treasury securities. This has caused a global rally in yields. Over the last month, the major Equity Indexes have fallen nearly 4% from the heights reached back in the good old days of April. This is not a huge measure of decline in the grand scheme of things, as we have certainly experienced worse in our new generation and reality of volatility.
Still, the gut feeling is that more pain, perhaps more dramatic, is yet to come, particularly on the heels of the Trade negotiation fallout and further repercussions which may arise. For those of us who can’t stomach the roller coaster we are riding we are just trying to keep it G-rated. In the words of Punky Brewster, Holy Macanoli!!!
Overall Market Insights
While trade is roughly 85-90% of the issue, there are other matters to speak of. This past week, the Fed released the minutes from its latest FOMC meeting. Despite all the rhetoric and push coming out of the current administration, and a clear yet comfortable sub 2.50% 10-year Treasury, they don’t seem to be backing down from their stance on inflationary pressures and the need to be cautious as we look ahead into the near term. While many in the markets, including the President, have called for and predicted a rate cut by year-end, the Fed are the ones making that decision. At this point, one can wonder if they are even considering the potential for a rate hike as they continue their “patient” stance toward further policy adjustments.
No doubt the Fed is watching the markets closely. The fact the US economy continues to expand is certainly a key measure as to how they approach domestic monetary policy. However, they can’t ignore global pressures such as the slowing global economy, the economic consequences from the lack of a Trade deal between the US and China, and the potential domino effect staging from the political turmoil over the Brexit affair.
Those catalysts, along with inflationary pressures remaining well inside of the Fed’s target range, should be enough to turn the lightbulb on and figure out a course of action. Nonetheless, it’s a question of being proactive versus reactive. At the same time, the political circus in DC gets better each day. The battle for the Iron Throne and Kings Landing between the President and House Speaker Pelosi gets more comical by the minute. While House Speaker Pelosi has called for a family intervention to “help” the President in this time of need, the President believes “Crazy” Nancy (not to be confused with “Crazy” Bernie) has lost it. No matter which way one leans, this sort of rhetoric, while comical, is in no way helpful and can rattle markets even further. Bottom line is both sides need to come back from visiting ALF on Melmac and see the real issues facing our country.
Nonetheless, given the overall volatility and sense that a Trade deal has been put on ice for longer than we would all like to see, we are fearful the volatility will continue. A test of the 2.10% waters on the 10-year is now a distinct possibility before reaching the 2.50% range again.
After yesterday’s sharp selloff in Equities and rally in Treasury yields, this morning Stock Futures are looking to close out what has been a very challenging week on a positive note providing a glimmer of hope to an already rattled market base. As Andy Dufresne says, “hope is a good thing, maybe the best of things.” Yesterday, Treasury yields rallied 8-10bps across the curve with the 10-year UST yield finishing the day around 2.31%. While yields traded a bit higher in overnight trading, they have come back down since with the 10-year trading at the same 2.31% level at the time of this writing. With the rally in yields we are once again in an inverted 3-month to 10-year yield curve environment albeit ever so slightly, while at the same time the 2-10 year basis has remained steady or has even steepened.
Not really sure what to make of that and I will continue to search for someone a lot smarter than myself who can explain this further. Suggestions?
At the same time, generic LIBOR swap spreads have tightened into the Treasury rally as mortgage Convexity Hedging has taken center stage for lenders saddled with loans on their balance sheet. If anyone understood what I just said please let me know. Happy to talk.
Over in Commercial Real Estate, the market for financing remains very strong and the competition fierce. While Fannie Mae and Freddie Mac have pulled back on guarantee and servicing pricing levels for what we term fully capped business – i.e. business that counts towards their FHFA mandated $35B volume cap – they are as competitive as ever versus other outlets for “uncapped” business, which nowadays seems to be a majority percentage of what is getting done out in the market. Since the start of the latest round of market volatility, spreads had held up pretty well in the CMBS, CLO, and Agency CMBS markets – that is until late this week. In fact, the market scooped up nearly $10B in new issue CMBS and CLO transactions over the last few weeks with relatively little push back. New Issue AAA 10-year CMBS spreads were trading in the low-80s to swaps, however, they have since widened out to the mid-80s to swaps given where the latest two transactions (BANK 2019-BNK18 and BMARK 2019-B11) priced out in the market this week.
Over in Agency CMBS, the volume from lenders and New Issuance from Freddie Mac in their K and FRESB shelves continue to impress markets. Freddie Mac priced two transactions out in the market this week. The first a 10-year fixed rate securitization, FHMS K092, and the other its latest 7- year floating rate transaction, FHMS KF62, with both deals clearing at or near market spread expectations and totaling nearly $2.5B.
On the heels of that, spreads over in DUS and GNMA land were holding in very nicely despite the plethora of volume (“Jefe, what is a Plethora?” – one of my all-time favorites) and market volatility. That is until yesterday when the sharp decline in Treasury yields sent DUS, GNMA, and secondary Freddie spreads wider per each deal that traded hands in the market. There was a point yesterday where DUS and GNMA spreads were wider by 3-5 bps on the day, mostly concentrated on smaller transactions traded at higher premium levels. At this point, we would call spreads over swaps on 10-year Freddie K’s in the high-50s/low-60s, DUS 10/9.5 mid- to high-60s and GNMA PL with a 103-00 dollar high-60s/low-70s, and wider for lower par transactions. Nonetheless, while things may be a bit more stable this morning heading into the holiday weekend, we are cautious on Agency CMBS spreads from here. Given the overall sense of volatility in the markets the slightest level of turmoil can send spreads noticeably wider, especially if CMBS, Corporates, and CDX continue to show signs of weakness and Treasury yield continue to rally. Overall the market saw nearly $1B+ in DUS and GNMA volume this week alone, which makes sense given the rally in yields and end of month expectations.
That’s all from us for now. My plans for the long weekend are cleaning off the grill and driving the minivan wherever the wife and kids tell me. Yup, I’m really looking forward. Have a great day and an even better holiday weekend. Reach out if you need us for anything.