Sector Update

November 13, 2018

Sector Updates will take Thanksgiving week off and resume Monday, November 26.

Last week the financial markets were largely focused on both the mid-term election results as well as the November FOMC meeting.  The election results came in mostly as expected (Democrats taking control of the House, Republicans holding onto the Senate), and the FOMC meeting occurred with the overnight target rate left unchanged.  There was some choppiness throughout the week but overall yields ended the week mostly in line with the previous Friday’s close.  Treasury yields increased on the front end of the curve and declined on the long end of the curve, and the spread between 2-year and 10-year Notes finished the week approximately 4 basis points flatter at 26 basis points.  Treasury yields reached cycle highs across the curve at mid-week before rallying before the start of the weekend.

Investment grade spreads were mixed compared to the previous week.  The most significant spread movement occurred in tax-free muncipals and corporate debt.  Municipal debt largely moved tighter compared to Treasuries, while most corporate names mostly moved wider.  Mortgage-related bonds were mostly unchanged week-over-week, but over the past month agency MBS have cheapened up by 8 to 11 basis points for 15- and 30-year passthroughs.

Many portfolio managers remained active in the market last week.  Bank investors were particularly active in agencies and municipals, with additional purchases in MBS, CMOs and ARMs.  Agency investors mostly focused on bullets and callables in the 3-year area of the curve.  Purchases of MBS mostly included new issue 15-year paper and seasoned 20-year pools.  Spreads for hybrid ARMs remain near the wides for the year but were largely unchanged on the week; post-reset prepay speeds slowed down dramatically in October but are expected to pick back up in November.  Par handle floating rate SBAs continue to be a popular option for investors seeking uncapped floating rate instruments, particularly with the Fed expected to raise the overnight target rate in December.  In fixed coupon SBA product, the new DCPC auction took place last week and 20-year maturity bonds priced at 6 basis points cheaper than in the October auction.  See individual sector updates for additional details.

Friday’s 5-year Treasury closing yield of 3.04% was 38 basis points above the average over the past year and 30 basis points above the 2018 average.  The 10-year Treasury yield finished at 3.18% on Friday, 28 basis points above the year-to-date average and 35 basis points above the average for the past year.

Adjustable Rate Mortgage Market Update

We’ve seen a recovery in ARM demand in November after the sector widened out alongside all spread assets in October. The low dollar prices on newly originated ARMs has reduced the impact of increased rate volatility and the need for convexity hedging, a positive for the sector. Currently, ARM spreads remain near the wides of the year.

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Agency Market Update

The Treasury curve flattened somewhat on the week as short-term Treasuries sold off while debt on the longer end of the curve rallied.  Agency bullets mostly moved in line with Treasuries.  Agency bullets with 2- and 3-year maturities saw yields increase by 2 basis points and now yield 2.98% and 3.07%, respectively.

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Fixed Rate Mortgage Market Update

Yield spreads on current production coupons to Treasuries were mixed for the week.  Spreads widened slightly for 30-year MBS and tightened on 15-year MBS.  The theme in the MBS market continues to be lower dollar prices and wider spreads relative to the last several years.

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Municipal Market Update

Prices on municipals started the week steady. On Tuesday through Thursday they were mixed. Tuesday saw the front and the long-ends weaken, while intermediate maturities were steady. On Wednesday the front-end was steady, while bonds maturing 10 years and longer strengthened. On Thursday the front-end strengthened, while bonds maturing 10 years and longer were steady. On Friday prices strengthened across the curve.

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SBA Market Update

SBA activity was focused on the DCPC auction last week, which included 10yr, 20yr and 25yr terms.  Investors were also active last week in floating-rate SBA pools as yields on these pools should move higher if the Fed raises rates later this year, which should continue to drive demand in floating-rate SBAs.

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CMO Market Update

Last week we saw investor activity in roughly the same portions we saw for the month of October including full coupon sequentials and VADMs. Of note last week, we saw investor activity in slight discount GNMA CMOs. All else equal, I think we would all agree a GNMA CMO is a good pick when offered at or close to the same risk/return profile of a FN/FH CMO.

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