June 3, 2019
Apologies ahead of time—it’s broken record time again. The market closed out May with yet another bond rally as investors digested the latest trade news, with the big surprise making headlines early Friday morning that Mexico will be the latest target of tariffs. During the holiday-shortened week sovereign debt yields declined by 18-22 basis points from the 2-year Treasury on out the curve, and yields are down approximately 40 basis points in the past month alone and close to 60 basis points lower year-to-date. With the rally both agency bullets and callables resumed their recent widening trend. Yields on 3-year bullets ended the week down 22 basis points at 1.95%, and 5-year bullets finished the week 19 basis points lower at 2.01%. The market is now pricing in 2 rate cuts by the end of the year (as judged by Fed funds futures contracts) and the front end of the curve moved downward enough to steepen the 2-year to 10-year part of the curve to ~22 basis points. The 3-month to 10-year portion remains inverted and now stands at approximately -21 basis points.
Spreads on agency bullets moved higher for maturities of 2 years and longer. Callable agencies also continued to widen last week just as they have over the past month. As highlighted in the first chart below, investors can now barely reach 2.00% yields with 5-year maturities but spreads more than double to ~21 basis points for 7-year maturities. For portfolio managers looking to mitigate exposure to falling rates, maturities somewhere in between might make for a good fit. As highlighted in the next two charts, less-structured callables look extremely attractive from a spread basis (in gray, right axis); less-structured 3-year callables are trading at the widest levels since 2010, and 5-year callables are at the widest spreads since January. This likely has more to do with expectations of falling rates going forward, as investors would require greater compensation to assume the now very plausible call risk.
The below table reflects last week’s total issuance and call activity across the primary GSE issuers. Agency issuance again more than doubled to nearly $7 billion. Call volume was modest at $1.6 billion but, with the sharp decline in rates so far this year, call volume is expected to be very high over the coming weeks and months. Portfolio managers would be prudent to view updated cash flow projections for any callable bonds that may be rolling off soon (this can be done via the Client Portal on the Vining Sparks website).
Last Wednesday Freddie Mac passed on its issuance date for any new Reference notes, just as it has passed throughout 2019. This Wednesday is the upcoming announcement date for the Federal Home Loan to announce any Global issuance. Next Tuesday Fannie Mae has its upcoming issuance slot for Benchmark securities.
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP