November 1, 2021
For at least a few weeks now, we’ve talked about the yield curve flattening and what that could mean from a practical perspective for a portfolio manager if (and it isn’t a small if) a longer-term flattening trend emerges. Why has the curve flattened, and why might that trend continue? If the Fed raises short-term rates sooner than later, bond yields further out the curve could decline as inflationary pressures subside and growth prospects potentially dim. This looks to somewhat resemble the scenario that played out last week. What could cause the curve to steepen? If markets lose faith in the ability or willingness of the Fed to fight inflation, short maturity yields remain anchored by the Fed while longer maturities would move upward to adjust for increased future inflation expectations.
The paragraph above largely sums up the mood of the markets last week. It really began on the previous Friday (10/22) when Fed Chair Powell said, “The risks are clearly now to longer and more-persistent bottlenecks, and thus to higher inflation.” As previously written, one might think this would send yields higher; however, the acknowledgment of the issue along with assuring markets they’d use their tools to “guide” inflation down if it looked more persistent than transitory set rates markets abuzz. So, all last week, there was no shortage of the phrase “pull forward” being used to describe the timeline for the next Fed rate hike. A good illustration of this “pull forward” can be seen from Fed Funds Futures and their implied rates. According to a WSJ article, there was a “77% chance of a rate increase by July 2022 and 89% by September 2022. That is up from around 15% and 27% one month ago”. A bit of an abrupt move in only a few weeks’ time.
Markets were choppy last week, and busy chasing headlines. The curve finished the week decidedly flatter. Often mentioned in this space, the 2s-to-10s spread declined to 105 basis points, its lowest level since August. Shorter maturities decreased less (or increased in the case of the 2-year) than longer maturities. Friday also marked the final trading day of October, so also included further below are our regular looks at broad fixed-income and equity index returns. The biggest events on the calendar this week are the FOMC’s meeting and rate decision this Wednesday followed by Friday’s payroll report.
Today – Yields higher, curve marginally steeper, stocks largely higher
Yields on 2-, 3-, and 5-year maturities still near highs for 2021
Sector Commentary (click on links for more in-depth look)
- Government/Agency Space
- Bullet spreads unchanged last week
- Callable spreads wider
- 5-year and shorter 2-3 bps wider
- Longer maturities unchanged to 2-6 bps wider
- Last week, issuance $7.7 Billion — $123 Million called
- Agency CMBS, MBS, and ARMs
- SBA DCPC spread unchanged last week
- Spreads are 6 bps tighter over the past month, 11 bps tighter YTD
- Spreads on seasoned collateral can be higher, more premium risk though
- SBA Floating 7(a) Pool factors recently released
- Equipment loan pool speeds decreased for first time since March
- Real estate pools rose for the sixth time in seven months
- 51% of business owners have job openings unable to fill, topping 48-year highs
- Quality and cost of labor concerns highest since pandemic began
- Agency MBS spreads were tighter, 15-year 6 bps tighter and 30-year 6 bps tighter
- Freddie Mac PMMS shows mortgage rates moved higher
- 30-year rate at 3.14% (+5 bps from prior) | 15-year rate at 2.37 (+4 bps from prior)
- YTD — 30-year is + 47 and 15-year is +20 bps
- 30-year is +49 from all time low on 1/7/21 of 2.65
- 15-year is +27 from all time low on 8/5/21 of 2.10
- Agency CMOs spreads unchanged across the stack
- SBA DCPC spread unchanged last week
- Municipals – spreads widen nearly universally for the week
- BQ Munis, 5-year 7 bps wider, 10-year 2 bps wider, 15-year 6 bps wider
- GM Munis, 5-year 1 bp wider, 10-year 7 bps wider, 15-year 12 bps wider
- Taxable Munis, 5-year 4 bps wider, 10-year 2 bps tighter, 15-year 3 bps wider
- A-Rated Corporates – 2-year 2 bps wider, 5-year 4 bps tighter, 10-year 3 bps tighter
- Vining Sparks Interest Rate Products
- Rate volatility continued from prior week with swap rates closing mixed across a flattening curve
- Hawkish Fed comments have tamped down inflation and growth expectations
- Has led to the curve flattening with the pivot point around the 4-year part of the curve
- Desk activity slowed going into month-end, do see an uptick in commercial loan hedging activity
- Virtually all commercial loan hedging deals are now priced using SOFR, FF Effective, or Prime
What We’re Reading
Market Today | Daily
Weekly Recap | Weekly, Friday
Monthly Review (October) | Monthly, 1st business day
Brokered Deposit Rate Indications | Weekly, Monday
Investment Alternatives Matrix | Weekly, Tuesday
MBS Prepay Commentary (October) | Monthly, 5th business day
SBA Prepay Commentary (October) | Monthly, 10th business day
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.
Vining Sparks: MBS & Prepayment Update
This presentation looks back over 2021 and how different prepay models have performed so far this year. It is always important, but especially in this environment, that robust prepayment assumptions are used. We also make note that Yield Book is scheduled to release a model update and provide some background and comparisons.
Vining Sparks: Loan Trading: Auto Market Analysis
Auto loans continue to be a large part of our customers’ loan portfolios and a participation class that remains in favor. It is important to stay abreast of market changes in rates and potential credit concerns that may be creeping in that could impact production and performance.
Vining Sparks: Strategic Insight: New SBA 504 Debt Refinancing Program
The SBA recently published a rule implementing section 328 of the Economic Aid Act. Section 328, titled Low-Interest Refinancing, revises the requirements for refinancing debt with an SBA 504 Loan. The net effect of these revisions points towards greater ease and availability for certain borrowers, who were previously disallowed, to refinance using an SBA 504 loan.