Sector Update

September 10, 2018

Treasury yields across the curve increased meaningfully last week, with yields for maturities of 2 years and out increasing by approximately 8 basis points.  At the end of the week the 2-year Treasury reached a new cycle high of 2.71%, the highest level since 2008.  The spread between 2- and 10-year Treasuries was essentially unchanged at 24 basis points.  Economic reports, especially the jobs data, appeared to be the driver of declining bond prices.  Markets now seem to expect an overnight rate hike at the end of the month, making it the 8th rate hike in this tightening cycle.

There was little change in relative value between sectors last week.  Credit risk continued to underperform optionality as callable agency debt spreads mostly finished tighter while corporate debt yield spreads were largely unchanged versus Treasuries.  In nearly all cases spreads finished either unchanged or within 5 basis points of the week prior.  Over the past month, municipals and mortgage-related spreads over Treasuries appear to be the only wider sectors in general.  Regardless of relative value, absolute yields across the short end of most sectors are at or near the highest levels of the past several years.

With the start of the new month plus the holiday on Monday, activity last week was somewhat light but picked up as the week progressed.  Some investors continued a recent trend and traded ahead of Friday’s jobs report by locking in purchases on Thursday, specifically in 7-year callable agencies.  Extension swaps in the municipal sector continues to be a popular trade—demand remains high for front-end municipals in the general market, and the longer end of the municipal curve remains steep compared to the Treasury curve.  In mortgage-related product, purchases mostly consisted of seasoned 15- and 20-year MBS with lower coupons trading at a discount as well as plain vanilla front and intermediate sequentials.  In the SBA sector the market will be looking to the new SBIC auction to see where it prices toward the end of this week or beginning of next week.  The last auction in March saw SBIC paper print at 38 basis points over Treasuries.

Friday’s five-year Treasury closing yield of 2.82% exceeded the daily closing average so far this year by 14 basis points and by 34 basis points over the average over the past year.  The ten-year Treasury finished at 2.94% Friday, 9 basis points above the year-to-date average and 25 basis points above the average for the last year.

Adjustable Rate Mortgage Market Update

Adjustable-rate mortgage flows have been flat to start the month as the focus remains on the fixed-rate origination cycle despite yields moving higher.  Dollar prices on newer issue ARMs remain attractive, with most new issue 10/1s trading between 100 and 101 (compared to 103 and 104 in 2016 and 2017).  With mortgage rates being stable for months now, the low dollar price on new production indicates that primary/secondary spreads have moved tighter in the agency ARMs market this year.

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Agency Market Update

The Treasury market sold off last week, particularly after the strong jobs report on Friday, and Treasury yields ended the week approximately 8 basis points higher for maturities of 2 to 10 years.  Agency bullet yields moved in lockstep with Treasuries.  Yields for 2-year bullets are trading at 2.77%, 3-year bullet yields increased to 2.84%, and 5-year bullets now yield 2.90%.

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Fixed Rate Mortgage Market Update

Yields spreads for current production coupon MBS to Treasuries were essentially unchanged for the week.  However, yield spreads are wider by 4-5bps over the past few weeks and have reached close to the widest levels of the year, despite implied volatility remaining stable and prepayments behaving in a tame fashion.  The cheapening trend in 2018 has been meaningful, with yield spreads on 30-year MBS widening by 17bps and spreads on 15-year widening by 13bps.

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Municipal Market Update

Prices on municipals on Tuesday and Wednesday weakened across the curve. On Thursday they were mixed, as bonds maturing 10 years and in were steady, while the longer-end weakened. On Friday prices on municipals weakened across the curve. Volume for the week is projected to be $6.3B, which is well above last week’s $2.3B in revised issuance.

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SBA Market Update

SBA activity was focused on the DCPC auction last Thursday, which included 10yr, 20yr and 25yr terms.  Demand for DCPCs and SBICs (SBIC semi-annual auction pricing later this week or next) remains strong as they offer superior convexity profiles to most residential MBS alternatives, while offering comparable yields and spreads.

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CMO Market Update

I’ve got a couple things for you this week. First, for anyone who missed it last week, I’ve included the August Trade Summary below. Lastly, I’ve included “Structure Highlights” so you can compare and contrast bonds similar to those we saw customer interest in last week.

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