Sector Update

April 16, 2018

Investment grade market yields moved higher all across the term structure last week, with the shorter end of the maturity spectrum climbing more than the long end. This resumption of clockwise curve twisting reversed last week’s defiant move in the opposite direction, as the longer-term trend toward a flatter curve resumed. Yields for US Treasuries maturing between two years and five years finished last week 8bp to 10bp higher, while yields for those maturing ten years and beyond increased by less than 5bp.

Most other investment grade sectors lagged the upward yield movements in Treasuries last week. Implied volatility edged lower despite international tensions and, by most measures, now lies closer to the trend lines of 2017 than to the elevated levels reached during the February spike. Lower volatility and the flatter curve pulled mortgage yields closer to Treasuries and also caused some tightening of callable debt spreads. Meanwhile, corporate debt benefited from favorable earnings trends based on quarterly results, and spreads between investment grade issues and Treasuries moved 2bp to several basis points tighter depending on terms and individual names.

Portfolio managers seemingly emerged from their torpor last week, with two-way activity picking up in many investment grade products. During the prior couple of weeks, activity largely consisted of cash redeployment. While reinvestment from recent redemptions continued last week, the volume of adjustments to portfolios via bonds swaps and minor portfolio restructuring picked up markedly last week. Some of this volume represented simple extension trades to realign portfolios with long-term objectives. Reallocations also occurred based on changing relative value views. The flatter curve drove some trades, modifying relative merits of different bond structures. And in municipal markets, the lower 2018 tax codes has changed the relative economics of taxable versus tax free debt, especially for the short end of the curve.

Friday’s five-year Treasury closing yield of 2.67% exceeded the daily closing average so far this year by 14bp and was 59bp higher than the average since one year ago. The ten-year Treasury finished at 2.83% Friday, 8bp higher than the year-to-date average and 41bp above the average for the last year.


Adjustable Rate Mortgage Market Update

The rally in interest rates caused yield spreads between fixed-rate MBS and Treasuries to grind tighter by 2 to 3 bps on the week.  For the past two weeks, hybrid ARMs have managed to lag the tightening experienced in fixed-rate MBS, making the sector more attractive on a relative basis. 

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Agency Market Update

Last week, Agency yields rose across the curve, particularly for shorter-term maturities, which flattened the curve. The movement in rates came after various geopolitical risk and volatility, followed by some relief in risk assets. Two-year Agency yields moved higher by 10 bps to 2.45%, the 5-year Agency yield increased 9 bps to 2.79%, and the yield on the 10-year Agency was up 6 bps to 3.13%.

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Fixed Rate Mortgage Market Update

MBS yield spreads versus Treasuries tightened, as Treasury yields rose across the curve.  15-year mortgage rates rose 4bps last week, continuing the trend higher this year, while 30-year mortgage rates were unchanged. Mortgage applications fell as both purchase and refinance applications declined for the second consecutive week. 

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Municipal Market Update

Municipal bond funds reported investors pulled cash out of funds for a second week in a row, as weekly reporting funds experienced outflows of $244.735MM, after experiencing outflows of $247.111MM the week prior. The four-week moving average turned to a negative $2.401MM, after being a positive $143.568MM the week prior.

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SBA Market Update

The SBA sector enjoyed greater than normal investor attention last week. Availability of fixed-rate SBA products from recent auctions and obvious relative value positioning of both SBIC and DCPC offerings resulted in greater than usual trading volumes, while expectations of further short-term rate moves and the overall flattening of yield curves continued to offer compelling reasons to buy floating-rate bonds, including SBA 7(a) pools. 

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