By Serafino Tobia, Greystone Director of Agency CMBS Securities Trading and Pricing
Treasuries
10-year Treasuries are at 4.45%, lower by some 0.18% after the CPI inflation print on November 14. CPI numbers were better than expected – the closely watched Core CPI (ex-food and energy prices) came in at 0.2% for the month of October (recall that Core CPI was at 0.3% for the previous two months). Data on inflation likely takes away a further Fed Funds rate increase at the December FOMC meeting December 13th, and if confirmed over the next number of months, gets us moving in earnest to the Fed’s 2% target inflation. The contrary view is that getting from a 3%-handle inflation to 2% will be sticky and slow and that will keep the Federal Reserve holding the Fed Funds rate “high for longer.” In other words, interest rates are data dependent.
We are now at a new low of the recent range. Recall, just three weeks ago, the 10-year Treasury was at 5.02%, the cycle peak since the Fed started moving rates higher some 20 months ago. Last month, rates started moving lower after Bill Ackman (CEO of Pershing Square hedge fund) tweeted about covering his short positions in long-dated US Treasury bonds. Ackman’s tweets likely pushed other short sellers to cover (i.e. buy back), which spurred an overall sentiment change as well. Interest rates moved another leg lower November 1st after the US Treasury’s announcement of only modest increases in bond auction plans and the Federal Reserve’s FOMC decision to pause again any Fed Funds rate increase (coupled with a dovish change in Fed Chairman Powell’s comments). Interest rates moved lower again after the October employment report on November 3rd. The jobs report indicated a softer labor market with only +150,000 new jobs (that was after last month’s oversized +336k job growth) and a 0.1% increase in the unemployment rate to 3.9%. That said, today’s CPI numbers helped the narrative that we are on a path to lower inflation and lower interest rates.
Keep in mind, there are several cross currents impacting Treasury yields as well. We still have a strong economy; the unemployment rate is at 3.9% as of last month and production is strong (3rd Quarter 2023 GDP registered at +4.9% annualized, up from a +2.1% pace for Q2). Additionally, the supply and demand for Treasury bonds has demonstrated weakness, evidenced by the last two US Treasury auctions of 30-year bonds where buyers didn’t show as expected. Demand from the core legacy buyers of Treasuries has waned (after a year of higher rates and portfolio losses), the Federal Reserve is now a seller of Treasuries (Quantitative Tightening, QT) and foreign investors have backed away a bit as well. The Bank of Japan is adjusting in its domestic yield controls to allow their rates to move higher; this will likely spur Japanese investors to repatriate funds to Japan and out of US Treasuries.
In the background, Moody’s moved the credit rating outlook for the United States to negative citing the inability of the divided and polarized US government to control fiscal deficits and the ballooning size and cost of the national debt. S&P and Fitch had both already reduced the US credit rating to AA+; Moody’s still has the US at Aaa (but now with the outlook “negative”). We are approaching a potential government shutdown on November 17th without Congress passing a spending plan; however, a temporary spending plan into January 2024 is fully expected. At this point, the bond market isn’t reacting in any material way to Moody’s’ outlook change nor to a possible US government shutdown. The Israel-Hamas war could broaden and may also impact economic conditions; here again, however, the markets aren’t factoring in any material impact on the economy (case in point, WTI crude oil is at $79.7/barrel as of this morning vs. 91+ mid-October).
Before the next Fed meeting and rate announcement on December 13th, we will get a good amount of additional economic data including production, November’s employment report, and inflation data (both the PCE index on 11/30 and another look at CPI on 12/12). Another 0.25% added to the Fed Funds rate at the December meeting or not, we should expect the Fed to stay diligent to bring inflation down to its 2% target (i.e., “high for longer” Fed Funds rates).
Don’t expect 10-year Treasuries to improve substantially lower from 4.50% +/-. We’ve already seen a significant improvement in long rates from 5.02% three weeks ago. Further, long-Treasury investors need to get compensated for taking on the term risk and with the Fed Funds rate target at 5.25%-5.50% currently and unlikely to be lower over the next several months, without evidence of a weaker economy and sustained lower inflation, 10-year rates are somewhat anchored at these levels.
FNMA and GN/FHA spreads
Agency CMBS and FHA/GNMAs spreads are flat +/- on the week; that’s after Fannie Mae DUS spreads moved lower by 4-5 basis points the previous week. Greystone is quoting 10/9.5s with 30-year amortization at 75 bps over 10-year treasuries. Fannie Mae spreads are on the lower end of this year’s range. For perspective, over this past year, the range has been as low as mid-low 60 (earlier this year) and as wide as 102 over (post Silicon Valley Bank/Signature Bank insolvencies in March).
FHA/GN spreads are still relatively high; spreads had moved higher by some 70 basis points higher after SVB/Signature Bank insolvencies in March. We’ve improved by 10-15 basis points since then, but spreads have remained stubborn reflecting regional bank investors having pulled back. Additionally, as you may know, the primary investors for the individual FHA loans are the Ginnie Mae REMIC accumulators (Wall Street dealers) that re-package the individual Ginnie Maes into sequential pay Ginnie Mae REMIC securities (creating extra value for the borrowers and the dealers when the yield curve is upward sloping). The inverted yield curve has reduced the value of the sequential pay Ginnie Mae REMIC structure.