Sector Update

February 12, 2018

Volatile bond markets left mixed yield outcomes across bond market terms and sectors last week. In the Treasury market, yields for the intermediate terms, two through seven years, fell, while the yields in the wings of the curve escalated. Even though the outcomes were opposite for different terms, sizeable yield changes of 6bp or more occurred in both directions. At times bond markets moved quickly, as bonds shared in the volatility surge displayed in equities and commodities.

While yield outcomes varied between sectors, no major shifts occurred in relative value last week and some of the changes in yield spreads seemed more related to volatility and timing than to credit concerns, changes in issuance expectations, or prepayment variations. Yield spreads versus benchmark Treasuries pushed slightly wider for much of mortgage-related sector, 1bp to 5bp. The fact that the portion of the Treasury curve used for benchmarking these spreads underwent a downward yield shift, while the balance of the Treasury curve moved upward, caused much of the changes in measured spreads. In this way, last week provides good evidence of the superiority of Z-spreads as a relative value measure for most mortgage products versus the more commonly used I-spread. Mortgage spreads did widen the prior week on convexity concerns though, and trading levels last week preserved that widening. Municipal yield spreads versus Treasuries finished the week slightly wider, finishing at levels in line with the prior week. Yield spread directions in the corporate sector varied, with more names widening than tightening.

While volatility continued to stimulate elevated levels of portfolio manager activity last week, the amount by which volume increased since the initial surge in volatility a couple of weeks ago falls short of what might have been expected. Last week the nature of business included some minor restructuring via bond swaps and outright purchases funded with recent redemptions or other cash sources.

Friday’s five-year Treasury closing yield of 2.54% exceeded the daily closing average so far this year by 14bp and was 58bp higher than the average since one year ago. The ten-year Treasury finished Friday at 2.84%, 23bp above the year-to-date average and 50bp above the average for the last year.

Adjustable Rate Mortgage Market Update

Yield spreads on new-issue hybrid ARMs to Treasuries were stable last week, while fixed- rate MBS widened out 4 to 7 basis points.  This continued outperformance by ARMs likely represents the lack of supply, relative value versus MBS (see table below), investor preference for lower duration, and the potential for better returns in higher rate scenarios compared to other mortgage-related alternatives. 

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Agency Market Update

Agency yields moved lower this week, with most of the movement occurring in shorter term finals, resulting in a steeper yield curve.  Two-year Agency yields fell 10 bps to 2.09%, 5-year Agencies declined by 9 bps to 2.58%, and yields on 10-year Agencies decreased by 1 bp to 3.18%

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Fixed Rate Mortgage Market Update

Mortgage-related security yield spreads versus Treasuries widened again last week, as volatility continues during the selloff in the financial markets. Mortgage rates were up one basis point last week and have increased 45bps this year. MBS prepayments slowed for the third consecutive month, declining for seasoned and new production and for high and low coupons.

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Municipal Market Update

Municipal bond funds reported investors put cash into funds for a fifth week, as weekly reporting funds experienced inflows of $674.908MM, after experiencing inflows of $235.926MM the week prior. The four-week moving average was positive at $717.654MM, after being positive at $815.115MM the week prior.

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SBA Market Update

As we have observed over the past few weeks, activity in the SBA market continues to be squarely centered on fixed-rate DCPC structures and purchases of USDA loans on the secondary market.  Last week investors added DCPCs from the February auction.  Although floating-rate SBAs continue to trade, the majority activity is in par handle floating-rate issues.

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