November 13, 2017
Agency yields increased across the curve last week, moving in lock-step with the rise in Treasury yields. With the stock market falling after last week’s unveiling of the Senate tax plan, the rise in Treasury yields is more a result of rising yields in the European market than any optimism surrounding tax reform. Two-year Agency yields increased by 3 bps to 1.71%, 5-year Agency yields improved 6 bps to 2.11%, and yields on 10-year Agencies were higher by 7 bps to 2.74%.
Yield spreads for Agency bullets compared to Treasuries were unchanged except for 2-year bullets, which experienced a tightening of 2 bps. Yield spreads for callable Agencies widened 2 bps on structures with 5-year finals, but tightened 1 to 2 bps for 15-year finals. In the near term, expect agency note spreads to trade in recent ranges. In terms of relative value, structures with 2-year and 5-year finals offer the most compelling spreads compared to bullets.
The following table reflects last week’s total issuance and call activity across GSE issuers:
|Federal Farm Credit Banks||497,000,000||30,000,000|
|Federal Home Loan Banks||268,000,000||15,000,000|
|Federal Home Loan Mortgage Corp||75,000,000||40,000,000|
|Federal National Mortgage Association||300,000,000||15,000,000|
|Federal Agricultural Mortgage Corp||26,000,000||–|
Last week, the Federal Home Loan Bank, as expected, passed on its global bond issuance slot. Freddie Mac announced today that it plans to issue a new three-year reference note due on November 17, 2020. The issue will be priced on Tuesday and will settle on Wednesday at benchmark size. The highlight of the agency coupon calendar in the upcoming week will be Fannie Mae’s announcement on Wednesday of any plans to sell benchmark notes.
Fannie Mae and Freddie Mac have transferred credit risk on a third of the $5 trillion of outstanding mortgage debt they guarantee. As a result, private investors could bear 60-90% of the losses on these mortgage loans. However, while credit risk sharing notably reduces the GSEs’ risk of severe loss during crisis times, it does not reduce the risk of a draw on the Treasury in the near-term, especially in light of potential tax reform implications on GSE capital.
Despite a subdued week of trading, we observed continued demand for callable paper out past five years. There is also opportunity with discount auction paper, specifically FHLB and Farm Credit, which is not adversely affected by the low volatility and tight swap spread environment. Recently, Freddie Mac has been the dominant name for cheaper funding although on Thursday FHLB loosened their funding target about 1 basis point putting them in direct competition for cheaper funding.
Ricky Brillard, CPA
Vining Sparks, IBG