August 12, 2019
Bond yields continued to move lower last week with the market largely trading off news of global trade tensions and threat of a currency war with China. Treasury yields for 2- to 10-year maturities are now down between 130 and 150 basis points from the cycle’s peak in November after falling 6 to 10 basis points last week. Yields on 3- and 5-year agency bullets declined by 8 basis points and ended Friday at 1.67-1.68%. As judged by the slope between 2- and 10-year Treasury Notes, the yield curve flattened to a cycle low of 9 basis points on Thursday and ended Friday only marginally steeper. As judged by Fed funds futures contracts, the market is fully pricing in at least 50 more basis points worth of rate cuts and better than 50/50 odds of 75 basis points of cuts by the end of the year.
Spreads for bullets were unchanged on the week while callables largely widened, particularly on the longer end of the curve. Spreads on callable bonds are now generally at the widest levels in over a month, which is not surprising given how far yields have moved down and the fact that callables generally trade at their widest levels when the yield curve is inverted (as it is today). Before overallocating to callables, portfolio managers should consider the implications of an inverted curve and the belief that the Fed is likely to ease monetary policy at their next several FOMC meetings. The major GSE issuers are highly efficient with their use of calls, and the added yield versus bullets may not outweigh the additional optionality.
The below table reflects last week’s total issuance and call activity across the primary GSE issuers. Call volume increased to $6.5 billion last week and holders of callable paper can continue to expect their principal dollars to roll back now that yields in the intermediate portion of the curve are at the lowest levels in nearly three years. As mentioned in previous Sector Updates, portfolio managers can go to the Client Portal on the Vining Sparks website to view updated cash flow projections for any callable bonds that may be rolling off soon.
Last week Freddie Mac passed on its latest issuance slot just as it has all year. It last issued a Reference note in June of 2018 and will not have another issuance slot until September 24th. The Federal Home Loan Bank also declined to issue Global notes last week. The Federal Home Loan Bank has another announcement date this Wednesday, August 14th, and Fannie Mae has its next announcement date for Benchmark securities next Wednesday.
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP