Interest Rate Market Commentary: How Times Change

May 17, 2023

The longer-term Treasury bond market is consolidating and settling interest rates at around 3.50%, measured by the 10-year Treasury rate.

By Serafino Tobia, Managing Director & Head of Agency CMBS Trading, Greystone

US Treasury Rates Stay Range-Bound

The longer-term Treasury bond market is consolidating and settling interest rates at around 3.50%, measured by the 10-year Treasury rate. Two and a half months ago, the 10-year Treasury rate marked a recent high at 4.06% (on 3/2/23) just before the insolvency of Silicon Valley Bank and Signature Bank. 10-year Treasuries dropped some 40-50 basis points in the 3-4 days following and have been in the range of 3.50% since then, registering a low of 3.30% back in early April, and a recent high of 3.60% in mid-April. The current 10-year Treasury is at 3.55%; therefore, it seems we are again approaching the high-end of the recent range.

2-year Treasuries are currently at 4.07%. Just before SVB and Signature Bank in early March, the 2-year was at 5.07%. Since then, we’ve been in a range of 4.00% plus or minus 20 basis points.

Future Short-Term Rates Implied by the SOFR Yield Curve

Two weeks ago, the Federal Reserve moved the Fed Funds rate another quarter point (0.25%) to a range of 5.00% to 5.25%. Currently, the overnight and one-month SOFR is about 5.06%, the six-month SOFR is 5.04%, one-year SOFR is 4.70% and two-year SOFR is 3.95%.

By the shape of the SOFR yield curve over the next two years, it’s clear that the markets are thinking that the Fed Funds rate stays at about 5% for the next six months, and then start coming down fairly rapidly. For six-month SOFR to be at 5.04% and one-year SOFR to be at 4.70%, that implies that the SOFR rate during the 2nd six months must be somewhere around 4.30%, or 74 basis points lower. With two-year SOFR at 3.95%, looking out two years, short rates move even lower – the yield curve implies SOFR rates at 3.20% in the 2nd one-year period.

Key Issue is Inflation

The forward rates implied by the yield curve certainly give pause. For the Fed Funds rates and short-term SOFR rates to come down, there will need to be continued improvement with inflation. Announced last week, CPI, year-over-year, broke through 5.00% for April (4.90%). That’s down from 6.50% earlier this year (and from just over 9.00% last summer). The PCE Price Index, the Fed’s preferred inflation index, registered 4.20% for March, down from 5.00% in February. Look out for the April reading of the PCE Index on Friday, May 26th.

Part of the story is an expectation that there will be a recession later this year or next and, with that, slower employment growth and an unemployment rate moving up towards 4.00% or higher. However, the economic data is still giving us mixed signals – the unemployment rate is currently at 3.40% (a historical 50-year low); we continue to see non-farm payroll growth at more than 200,000 new jobs per month; April’s employment report was an upside surprise at 253,000 new jobs added. Job growth would need to be below 100,000 per month for the unemployment rate to move higher.

It's debatable whether inflation will continue to come down so quickly. The improvement we’ve seen since last summer was the easy part – in large part “transitory” due to supply chain disruptions. Core CPI registered a 0.40% increase month-over-month (or 4.80% annualized). Getting from around 5% inflation down to the 2% Fed Reserve target inflation will be difficult.

Next Fed FOMC Meeting

The Fed’s FOMC committee meets June 14th to decide to either increase the Fed Funds rate another 0.25% (putting the target level at 5.25% to 5.50%) or to pause rate hikes. Our thinking today is that the Fed will pause, as a 5.05% Fed Funds rate is in the restrictive territory with inflation below 5%.

Fed Chairman Powell’s view is that monetary policy works with “long and variable lags” and the Fed will likely want to pause at some point to give the higher rates some time to move through to the economy. Further, the Fed will want to see how the recent stress in the banking system affects credit availability and the economy. Before the next FOMC meeting, there will be another PCE Index inflation read (5/26) as well as May employment numbers (6/2), CPI (6/13) and PPI inflation numbers (6/14).

10-year Treasury Rate Over the Near Term

We expect 10-year rates to continue to be range bound at around 3.50%. It’s unlikely that 10-year rates will move much lower as there is no clear path to get there. We will need to see inflation move significantly lower – which is likely far off. We also don’t see rates moving in the opposite direction, much higher, either. To reiterate, a “hawkish Fed” (intent on bringing inflation down to its 2% target) will keep an upside bound on the range of 10- and 30-year rates.

FHA and Agency Multifamily Market Spreads

Recapping on market spreads for both Fannie Mae DUS and FHA/Ginnie Mae (GNMA) securities, they widened by upwards of 40 basis points after the SVB/Signature Bank insolvencies in early March. Fannie Mae spreads have come back to around 25 basis points wide to pre-SVB levels, but GNMA spreads have stayed fully 40 bps wide.

Spreads are wider due in large part to a pullback in investing by regional banks. Suffering from the withdrawal of deposits above the FDIC-insured deposit level, they have stepped out of the securities markets to maintain liquidity. Regional banks had been a mainstay investor base for Agency securities and GNMA REMIC securities.

The markets are also weighed down by the sale of the mortgage security assets that the FDIC acquired from Silicon Valley Bank and Signature Bank, including $100 billion of single-family mortgage securities. Last week, The FDIC (through their agent, Blackrock) sold about $500 million of Freddie Mac K-series securities (pools of multifamily loans with an average life of between 7.5 to 8.5 years). There will be additional sales of Freddie Mac K-series securities over the next couple of weeks totaling about $1 billion.

After that, the FDIC and Blackrock will sell $12 billion of Ginnie Mae REMIC securities. Greystone’s GNMA/FHA project loan buyers are primarily the dealers that accumulate the individual Ginnie Maes and package them into GNMA REMIC securities. The GNMA REMIC dealers continue to hold back and keep spreads wide, reflecting concern over the extra supply and the reduced demand from the regional banks.

This month, Credit Suisse is also selling $400 million from its holdings of Ginnie Mae CLCs – construction loans. Just a bit of history – Credit Suisse was the largest of the REMIC accumulators during the late 1990s and early 2000s when the REMIC securitization business first started out. Credit Suisse was by far the number one buyer of Ginnie Mae project loans. Now, after the forced merger with UBS – they are no longer in this business.

Interesting how times change.

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