Sector Update

February 5, 2018

Yield increases and pronounced curve steepening occurred across all investment grade bond market sectors last week. Treasury yields displayed this outcome with yield increases of 15bp to 20bp for all terms seven years and beyond and only a 4bp increase for the two year. While still flat based on post-crisis history, 16bp of steepening of the two-year vs ten-year yield spread reverses much of the recent flattening trend and leaves this spread at the widest since November 10th of last year.

While not all bond sectors moved in the degree of synchrony displayed in the prior several weeks, smallish variances relative to the large movement in the yield curve only impacted relative value in minor ways. The mortgage sector underperformed Treasuries by a few basis points, a fairly typical occurrence, as spreads in the sector often widen in large sell-offs. Callable agency structures also underperformed, probably for the same reasons as mortgages: a reaction to duration extension and greater implied volatility. Spreads in the short end of the corporate sector also widened, while longer term investment grade bonds mostly moved in tandem with Treasuries. Municipal yield spreads moved in fairly similar fashion to the balance of debt markets for a second consecutive week, with mixed yield spread outcomes versus Treasury benchmarks depending on term, structure, and credits.

Portfolio managers reacted to higher yields and greater market volatility last week in varied ways. Many put cash to work, as the attraction of greater yields and also , in some cases, the crossing of targeted levels enticed investment of pockets of cash. Significant accumulation remained from recent heavy redemptions, so this activity became brisk at times. Other portfolio managers sought to protect higher yields by reducing negative convexity or to avoid further duration extension, resulting in increased volume of bond swaps. While inconsistent at times, high levels of transactions and inquiries occurred last week relative to the several weeks prior.

Friday’s five-year Treasury closing yield of 2.59% exceeded the daily closing average so far this year by 21bp and was 64bp higher than the average since one year ago. It was also the highest daily close since April 23rd, 2010. The ten-year Treasury finished Friday at 2.84%, 26bp above the year-to-date average and 50bp above the average for the last year. As an interesting coincidence, the YTD average for the ten year equals the Friday close for the five year.


Adjustable Rate Mortgage Market Update

Most mortgage-related sectors experienced some degree of spread widening in the face of the bond market sell-off in recent trading sessions.  However, yield spreads on new-issue hybrid ARMs to Treasuries have tightened approximately 1 to 2 basis points over the past two weeks. 

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Agency Market Update

Agency yields benefited from the steepening Treasury yield curve in a week filled with a sizeable selloff across the curve brought on by a combination of events, including movements in the U.S. Dollar and expectations of a more hawkish Fed. 

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Fixed Rate Mortgage Market Update

Mortgage related security yields increased again last week continuing the trend higher this year, as treasury yields and mortgage rates have pushed higher. Mortgage yields are currently in the upper end of the trading range so far for 2018. This increase in MBS yields drove 30-year mortgage rates 20bps higher last week and 45bps higher this year.

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Municipal Market Update

Municipal bond funds reported investors put cash into funds for a fourth week, as weekly reporting funds experienced inflows of $235.926MM, after experiencing inflows of $781.160MM the week prior. The four-week moving average was positive at $744.164MM, after being positive at $503.830MM the week prior.

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SBA Market Update

Activity in the SBA and related markets continues to be squarely centered on fixed-rate DCPC structures and purchases of USDA loans on the secondary market.  Although floating-rate SBAs continue to trade, the majority activity is in par handle floating-rate issues. 

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