February 24, 2020
We wrote last week that it had been hard to find information that is encouraging regarding the COVID-19 virus. That continued to play out last week as Treasury yields fell by 7-12 bps on maturities greater than 2-years. As real economic impacts from the spread of COVID-19 materialize and become more apparent, market volatility will persist. Notably, corporate earnings and now global supply chains may feel impacts greater than initially anticipated. Furthermore, over the weekend, news confirming global outbreaks in South Korea, Italy, and Iran have markets running. Worrisome to me, much still seems unknown about how exactly the Virus spreads. I invite you to look at a Coronavirus Chartbook our Economics team is maintaining.
As markets react to less than favorable news, equities are trading lower. The S&P 500 is down 2.7% and European markets are off by close to 4%. This morning, Treasury yields are down another 9-10 bps on maturities greater than 2-years and the curve is flatter/more inverted as markets continue to expect rate-cuts this year. The Fed seems fine with where overnight rates are currently, so it will be important to listen as they address more recent happenings. The 10-Year Treasury is flirting with an all-time low reached in 2016 and the 30-Year Treasury has hit a new record low this morning.
Food for Thought
Weekly, we publish the Investment Alternatives Matrix that lists representative yields and price volatility for a wide range of bond sectors and structures. As we look at this matrix each week, we consider which sectors and structures offer the most spread to Treasurys. Naturally, longer municipal bonds, both taxable and tax-exempt, are typically near the top of the list. However, not everyone wants a long-term fixed rate bond.
Some buyers prefer floating rate bonds versus fixed but want more spread or prefer a different underlying index than traditional floating bonds offer. If that is you, why not create your own floater using your preferred underlying index and the sector that offers the most spread?
You can combine that fixed rate bond with a swap and create a floating rate muni. You can convert a good credit 20nc10 taxable bond to floating until the call date at effective fed funds plus 105bps – that’s a current yield of 2.71%. That spread beats most other floating rate options by at least 50bps.
Advantages of creating your own floating rate bond versus a traditional floating rate bond include:
- An effective floating rate instrument with less premium risk and higher yield than other alternatives
- Can pick your choice of index (LIBOR, Fed Funds Effective, Prime, SOFR) without accepting the potential risk inherent in cash instruments tied to LIBOR
- The swap market value offsets the security market value loss if interest rates rise
- Retain liquidity in the fixed rate bond as losses in the fixed rate bond will be largely offset by gains in the interest rate swap
There are some risks:
- If spread relationships change, the change in value of the swap may not exactly offset the change in value of the security; this risk can’t be hedged.
- If the bond is hedged to a call date, there is tail risk. Can be managed by using a cancellable swap or adjusting the hedge in other ways.
Weekly Spread Commentary
- 2s to 10s was 5bps tighter, 16 tighter over last 30 days.
- Agency Bullets relatively flat, +1bp on 5- and 10-year maturities.
- Agency Callables 2-3 bps wider.
- MBS were 3 bps wider, 8-10 bps wider over last 30 days.
- CMOs were 2 bps wider.
- Corporates were 3 bps wider on the short end, and 1 bp tighter on the long end.
- BQ Munis flat to 3 bps wider on 5- to 10-year maturities. 15-year was unchanged.
- GM Munis widened by 10-13 bps at 5- and 15-year maturities. 10-year was 1 bp tighter.
- Taxable Munis +/- 1 bp on 5- and 15-year maturities. 10-year was unchanged.
What We’re Reading
Market Today | Daily
Weekly Recap | Weekly, Friday
Brokered Deposit Rate Indications | Weekly, Monday
Investment Alternatives Matrix | Weekly, Tuesday
MBS Prepay Commentary (February) | Monthly, 5th business day
SBA Prepay Commentary (February) | Monthly, 10th business day
“The rapid increase of cases outside of China spooked investors Monday, portfolio managers said, especially as questions linger about how exactly the virus is spread. Infections are now emerging in people who haven’t traveled to China or come into contact with confirmed cases.”
“The average rate on the popular 30-year fixed mortgage hit 3.42% on Friday, according to Mortgage News Daily. That is for borrowers with strong financials and credit scores. On Monday that rate could move even lower.”
Vining Sparks: Loan Trading: Auto Performance Update
“We continue to be very active in trading auto loan participations and analyzing loan portfolio compositions. We receive monthly performance reports on over $2.7B of auto balances, monitor more than 140 pools, and have over 6 years of performance information on our most seasoned pools. We continue to track the performance of individual pools and seller specific performance as well as consolidated analytics to determine any trends or risk factors occurring in the auto space.”
Adjustable Rate Mortgage Market Update
Yield spreads for new-issue hybrid ARMs remained stable last week, as the overall bond market rallied with yields falling further on economic worries related to the coronavirus. The yield on the benchmark 10-year note was down 5 bps to 1.47% and as of this morning, it is less than 1 basis point away from the all time low of 1.35% hit on July 8, 2016.Continue Reading
Agency Market Update
Agency bullets and callables both widened on the week. Intermediate and longer agency bullets continued their recent widening streak last week, but still very close to their 12-month averages. Callable agencies also widened with the rally, but the amount of call volume seen within the last year should be enough to make callable buyers wary.Continue Reading
Fixed Rate Mortgage Market Update
Nominal spreads on current coupon MBS compared to Treasuries were wider last week, with both 15- and 30-year widening 3 bps to 63 bps and 98 bps, respectively. As spreads have widened in recent weeks, we have seen strong demand for 15- and 20-year pools with relatively low coupons.Continue Reading
Municipal Market Update
Municipal prices started the week stronger across the curve. On Wednesday municipal prices were steady across the curve. On Thursday and Friday municipals prices strengthened across the curve. This strengthening in municipal prices, especially in the 10- and 30-year maturities, resulted in the municipal yields for these maturities reaching new lows.Continue Reading
SBA Market Update
SBA floating rate pools with uncapped quarterly resets indexed to Prime experienced a continued pickup in activity over the last month with the majority of the activity in higher coupon 10-year equipment pools priced at moderate premiums.Continue Reading
CMO Market Update
The trade desk has seen good activity with Modified Step collateral. These CMOs can have a similar profile to MBS backed by FNMA re-performing loans, that is loans that are current but had been delinquent in the past.Continue Reading