Sector Update

January 16, 2018

Interest rates for most of the investment grade debt market moved higher last week by small amounts, 6bp or less. Each of the last two weeks included small yield increases and curve steepening. Because of the smallish magnitude of the flattening, reading the changes for early 2018 as a reversal or even an end to the long-term trend toward a flat Treasury curve would be quite premature. Nonetheless, the short term reversal and the changes to which it has been attributed, most notably more upward adjustments to economic growth assumptions partially stimulated by tax code changes, warrant very close watching for the coming weeks.

Change in intra-sector relative value last week left corporate and US agency debt slightly more expensive and mortgage-related securities slightly cheaper. Investment grade corporate yield spreads versus Treasuries in general closed in by 2-3bp, US agency spreads contracted by 2bp or less, and mortgage-related securities mostly widened by 1-3bp. Changes in yield spreads between tax free municipals and Treasuries dwarf those occurring in other sectors, with longer maturities tightening by 8bp or more and extending a spread contraction that has lasted several weeks.

Portfolio managers seemed to ease into the market last week, slowly transitioning from year-end distractions and refocusing on portfolio needs and market opportunities. The recent uptick in yields rewarded a number of portfolio managers who, either by design or due to distraction, allowed cash to accumulate from recent redemptions, finally putting the money back to work last week. The number of bond switches also picked up, especially in the municipal market, as portfolio managers continue to evaluate the impacts lower taxes have on tax-equivalent yields. For the most part, portfolio managers seem to be just now beginning to evaluate market changes and impacts on holdings and refocusing on implementation of portfolio strategies.

Friday’s five-year Treasury closing yield of 2.35% exceeded the daily closing so far this year by 6bp and was 43bp higher than the average since one year ago. The ten-year Treasury finished Friday at 2.55%, 4bp above the year-to-date average and 22bp above the average for the last year.

Adjustable Rate Mortgage Market Update

Yield spreads on new-issue hybrid ARMs to Treasuries tightened 1 to 2 basis points last week. Higher yields and cheaper valuations relative to fixed-rate MBS have caused ARMs to tighten to begin the year.

Agency Market Update

For the second consecutive week, Agency yields rose, moving in lock-step with the increase in Treasury yields. U.S. Treasury yields were lifted by market expectations for higher supply due to fiscal expansion, the Fed’s balance sheet normalization plans given the step-up in reduced investments for this month, reports of lower demand from China, and firm economic data.

Fixed Rate Mortgage Market Update

Mortgage yield spreads versus Treasuries were generally unchanged last week as Treasury yields moved higher across the curve. This increase in MBS yields drove mortgage rates nine basis points higher.

Municipal Market Update

Municipal bond funds reported investors put cash into funds last week, as weekly reporting funds experienced inflows of $1.06B, after experiencing outflows of $47.880MM the week prior. The four-week moving average was positive at $271.840MM, after being positive at $59.822MM the week prior.

SBA Market Update

Last week brought limited activity in the SBA market, as many investors continue to attend to year-end administrative duties. The limited activity was centered on trading par handle floating-rate issues and the new issue DCPC.