January 10, 2022
A few points to start your week
- Yields moved significantly higher last week, continue to increase this morning
- Mark your calendars for upcoming webinars and register for tomorrow’s 1Q Economic Outlook
- Food for Thought section reflects on 2021 and three investment disciplines
- VSIRP “…the role of ALCO and bank management is not to predict changes in rates but to prepare for reasonable possibilities…”
Last week we wrote we would do well to remember, even though even though our calendars had flipped over to a new year, the same concerns exiting 2021 had not disappeared. Markets, notably Treasury yields, made this quite clear last week. Before we even had time to publish last Monday, yields were headed up, and fast with nothing new reported. Wednesday featured the release of the minutes from the Fed’s December meeting. The minutes heightened the odds the Fed could begin to raise rates at their March 16th meeting (their next meeting is January 26th). Lastly, Friday saw weaker than expected job growth combined with lower unemployment and an increase in hourly earnings. We will have more up-to-date reads on inflation this Wednesday and Thursday with CPI and PPI measures are released.
Yield movements last week were significant
Looking back 5-years, there was only one period with a larger week-over-week change in 5- and 10-year yields compared to last week. By my estimation, both moves last week were right at three standard deviations.
WSJ: The Best Investment for This Coming Crazy Year
I thought this was an especially timely article. In a nutshell, the author thinks discipline will be the best investment in 2022. I happen to agree, especially, since it is the crux of the Food for Thought section below. The article is geared more towards individual investors, but we face similar issues. Namely that we can’t predict the future, and with so much uncertainty, things that seem like a given may not be in actuality.
Today – Yields higher, curve slightly steeper, equities decline
Upcoming Webinars – (1 hour CPE available, registration opens 2 weeks prior to each webinar)
2/22 Bank: Positioning the Investment Portfolio for Performance
2/24 Credit Union: Positioning the Investment Portfolio for Performance
3/8 Bank: Balance Sheet Strategies in an Expected Tightening Cycle
3/10 Credit Union: Balance Sheet Strategies in an Expected Tightening Cycle
Food for Thought: Reflecting on 2021 and Looking Forward to 2022 (originally printed 1/3/2022)
Looking back, 2021 was an odd year in many ways but helped reinforce three (at least) good investing disciplines. We entered the year with absolute low yields. The 3-, 5-, and 10-year Treasury yielded 0.17%, 0.36%, and 0.92%, respectively, and didn’t provide much cushion for the historically modest 60-90 bps increase in yields. This pressured returns lower for the year, especially longer duration, after two solid years of performance. That isn’t to say all longer duration investments though (more on this below). Even on a 3-year Treasury, best I can tell, 2021 was the first year a buy-and-hold investor would have experienced a negative total return in over 20 years.
Discipline 1: Portfolio diversification matters
Like I mentioned above, not all longer-duration investments struggled with returns in 2021. A sizeable portion of many depository portfolios are invested in longer-term municipal bonds which performed relatively well. Last year was likely a good reminder of the merits of a diversified portfolio. Historically, this also appears to be the case too. Looking back to 2000, there has only been one year (2013) where all the selected indices below posted negative total returns.
Discipline 2: Invest as consistently as practical
At the risk of sounding self-serving, I really do think 2021 served as a good reminder on the merits of attempting to invest as consistently as possible. Looking at some of the charts below, there were certainly times when investing would have been more/less advantageous than others. This is the biggest problem we have as investors though, being unable to predict the future. Taking a disciplined approach to purchases is a way to help combat this.
Discipline 3: Don’t forget the big picture, your balance sheet
Considering what we’ve seen it is natural for one to wonder, what’s likely to perform well in 2022? Will the curve materially flatten, will credit continue to perform well, the list goes on and on. Fortunately, the answer to this question can (and I’d argue should) be determined by the rest of your balance sheet. Coming into 2021, the risk to yields falling was largely realized and the focus had turned to a prolonged period of low rates. Most balance sheets were (and still are) poised to perform well if and when shorter-term rates rise.
That brings us to today and to 2022. Risk sentiment seems to have shifted towards shorter-term rates rising as the Fed is expected to act on recent and persistent inflation. What if yields move higher, what if the curve flattens? Don’t worry about trying to predict the future, that’s an unrealistic goal. After all, last year the Federal Reserve predicted unemployment would be 5% in Q4 of 2021 (closer to 4% in reality) and that inflation would be up 1.8% (closer to 5%). The right choice is what complements your balance sheet.
Yields on 2-, 3-, 5-, and 10-year maturities remain above recent weekly highs this morning
Curve Shape – 2s5s moves steeper to start the year
Curve Shape – 2s10s starts the year steeper as well
Sector Commentary (click on links for more in-depth look)
- Government/Agency Space
- Bullet spreads were unchanged on the week
- Callable spreads moved tighter
- 5-year and shorter 2 bps tighter
- Longer maturities 8-10 bps tighter
- Agency CMBS, MBS, and ARMs
- SBA DCPC spreads 1 bp wider
- Monthly DCPC auction last week, strong demand
- Spreads on seasoned collateral can be higher with more premium risk
- SBA Floating 7(a) Pool factors expected to be released this week
- 16% of NFIB respondents list inflation as their single most important problem
- 49% still have job openings they are unable to fill, a slight improvement from previous at 51%
- Agency MBS spreads were mixed, 15-year unchanged and 30-year 2 bps wider
- Freddie Mac PMMS shows mortgage rates increased
- 30-year rate at 3.22% (+11 bps from prior) | 15-year rate at 2.43 (+10 bps from prior)
- YTD — 30-year is + 11 and 15-year is +10 bps
- 30-year is +57 from all time low on 1/7/21 of 2.65
- 15-year is +33 from all time low on 8/5/21 of 2.10
- Agency CMOs spreads were unchanged across the stack
- Spreads 5 bps wider on shorter maturities
- Spreads unchanged on longer cashflow structures
- SBA DCPC spreads 1 bp wider
- Municipals – tax-frees yields lagged Treasury move, spreads tighter
- BQ Munis, 5-year 18 bps tighter, 10-year 19 bps tighter, 15-year 20 bps tighter
- GM Munis, 5-year 18 bps tighter, 10-year 12 bps tighter, 15-year 27 bps tighter
- Taxable Munis, 5-year 1 bp tighter, 10-year unchanged, 15-year 1 bp wider
- A-Rated Corporates – 2-year 3 bps wider, 5-year 3 bps tighter, 10-year unchanged
- Vining Sparks Interest Rate Products
- Fed minutes reinforced near uniform belief that the Fed will increase short term rates this year
- Bankers should be watching and preparing for both changes in rates and shape of the curve
- The role of ALCO and management isn’t to predict changes in rates but to prepare for reasonable possibilities
- Thoughts to consider, invest cash, meet customer demand, and lock rates now
What We’re Reading
Market Today | Daily
Weekly Recap | Weekly, Friday
Monthly Review (December) | Monthly, 1st business day
Brokered Deposit Rate Indications | Weekly, Monday
Investment Alternatives Matrix | Weekly, Tuesday
MBS Prepay Commentary (January) | Monthly, 5th business day
SBA Prepay Commentary (December) | Monthly, 10th business day
“To see why discipline is such an important investing virtue, consider the history of interest-rate decisions by the Fed. The central bank appears to be projecting at least three 0.25% increases in interest rates this year, potentially starting in March. Most investors are treating that forecast as a foregone conclusion.”
“The point here isn’t just to poke fun at year-ahead forecasts, but to recognize that while it is useful to think about what things might look like in a year, it is more important to have a good idea of what is happening now and what could happen next—especially considering how much uncertainty the pandemic has created.”
Vining Sparks Interest Rate Products: Margin Compression: Causes and Solutions
In this article, we examine why the industry is facing margin compression, challenge some of the more prevalent assumptions about banks’ risks profiles and highlight our best ideas for dealing with the current environment.
Vining Sparks: Strategic Insight: Year-End Balance Sheet Management
As the end of 2021 approaches and planning for next year begins, we have developed several balance sheet and portfolio management strategies considering the current banking landscape and challenges that could weigh on future profitability. Additionally, we have updated our annual Year-End Checklist to help serve as a guide through the planning process.
Vining Sparks: Loan Trading: RV Market Analysis
Historically low interest rates, several rounds of stimulus, and pent-up travel demand all helped contribute to RV shipments ending 2020 with a 6% increase over 2019 and on par with the third best year ever despite shutdowns. Positive momentum has continued so far in 2021 setting new all-time highs in each of the last nine months.
Have you ever wondered why the price volatility you see on tax-free municipal bonds is less than comparable taxable bonds? At Vining Sparks, we consider taxes when measuring interest rate risk on tax-free municipal bonds. The rationale is simple: taxes matter. In this Strategic Insight, we look at the implications of ignoring taxes and why we think it makes sense to consider them.