Sector Update

March 23, 2020

As many have transitioned to working from home, new “firsts” are sure to be encountered. Personally speaking, it’s having The Jungle Book on in the background. The irony of “The Bare Necessities” isn’t lost on me. Early this morning, it was “A Whole New World” as the Fed announced virtually unlimited Quantitative Easing (QE). They removed purchase caps on Treasury and Agency MBS and clarified that Agency CMBS are included. They also established facilities to both purchase and finance corporate and municipal borrowings. The also revived a Financial Crisis era facility, the Term Asset-Backed Securities Loan Facility (TALF), to “support the flow of credit to consumers and businesses”. Finally, they broadened the range of securities eligible as collateral for their Money Market (MMLF) and Commercial Paper (CPFF) facilities. You could say they have taken QE “to infinity and beyond”. They do all of this to increase liquidity in markets, but the net effect of their actions is to attempt to reduce spreads. The “Food for Thought” section below will elaborate on this a bit.

Going into this morning, stock futures were pointing down on news that Congress failed to advance a fiscal stimulus bill but reversed once the Fed made their announcement. The Fed can only do so much though and currently, US stocks are down 2-3% and Treasury yields are lower. I doubt this turns around meaningfully until Congress passes some sort of fiscal stimulus.

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Food for Thought

As mentioned above and is apparent below in the “Spread Snapshot”, spreads are indiscriminately wide. In some areas, say BBB Corporates of highly-leveraged firms, spread widening is appropriate. In other areas, Pre-Refunded Municipal bonds for example, I’d argue that spread widening has gotten out of hand. Indiscriminately wider spreads are a symptom of illiquidity and exactly why the Fed stepped in (again) this morning. In the case of Pre-Refunded Municipal bonds, and remember, these are usually bonds that have been called and have Treasury bonds in escrow, spreads are at levels I’m not certain we have ever seen. I estimate that spread levels are 3+ standard deviations (easily) from the average over the past 5 years. I’d like to go back further but simply don’t have the data. As you consider spread opportunities, starting at the “top” of the credit spectrum is a wise move in my view. Pre-Refunded and Texas PSF Munis, not to mention Agency-backed bonds, certainly fit this criteria.

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 (March) | Monthly, 5th business day

SBA Prepay Commentary (March) | Monthly, 10th business day


CNBC: The Federal Reserve just pledged asset purchases with no limit to support markets

“That represents a potentially new chapter in the Fed’s ‘money printing’ as it commits to keep expanding its balance sheet as necessary, rather than a commitment to a set amount.”

WSJ: For Small Businesses, It’s a Virus Chain Reaction

“With fewer dollars coming in, small businesses have hard decisions to make about whether to pay rent, workers or bills from their supply chain, said William Dunkelberg, chief economist for the National Federation of Independent Business. ‘Somebody is going to get the short end of it,’ he said. ‘That will work its way back through the economy.’”

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Sector Updates

Adjustable Rate Mortgage Market Update

ARM spreads continued to widen as the broader fixed income market remained volatile.  Week over week, 5/1s and 7/1s experienced the most widening at 50 and 52 basis points, respectively, while longer-reset 10/1s widened 40 basis points.  At these wides, ARMs reversed course and underperformed mortgage-related sectors with 15- and 30-year fixed-rate mortgages widening 31 and 0 basis points, respectively, on the week.

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Agency Market Update

Agency bullets and callables both continued their widening streak last week.  Agency bullets with 2- to 5-year maturities widened by 7 to 10 basis points and as of Friday were trading at 30 to 35 basis point spreads over Treasurys.  Callables also widened to a similar degree in the 2- to 5-year part of the curve.

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Fixed Rate Mortgage Market Update

Nominal spreads on current coupon MBS compared to Treasurys were mixed last week, as 15-year increased 31 bps to 141 bps, while spreads on 30-year were stable at 153 bps. Spreads were volatile during the week reflecting a lack of consistent liquidity.

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Municipal Market Update

Municipal prices started the week mixed, and then weakened daily for the rest of the week. New-issue offerings are forecasted to be just $2.3B for the trading week.

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SBA Market Update

Fixed-rate DCPC yield spreads widened in the March auction and are wider than the twelve-month average for all maturity terms. SBA floating-rate pools with uncapped quarterly resets indexed to Prime have experienced a decline in activity and lower levels of supply the last several weeks as the Fed cut rates and markets were increasingly pricing in additional rate cuts.

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CMO Market Update

We saw wild moves in Treasury yields last week with some shorter maturities declining more 20 basis points. Despite this, fixed rate agency CMO spreads didn’t budge. Granted, they had already widened out significantly in recent weeks to multi-year highs. Interestingly enough, floating rate CMO spreads widened week-over-week and now offer approximately +50 basis points for 5-7 year bonds tied to 1-month LIBOR.

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