Interest Rate Market Commentary: Range Bound Pending Economic Data

July 01, 2024

Interest Rate Market Commentary: Range Bound Pending Economic Data

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

Despite the bond-friendly PCE inflation report on Friday, the 10-year Treasury yield has risen to 4.44% as of this morning, an 18 basis point increase since Friday. Yields moved higher with quarter-end profit-taking selling on Friday and further weakness this morning (likely related to short-covering and re-positioning before key employment data this week).  Since the end of May, 10-year bonds traded in a 40 basis point range:

  • High: 4.61% on May 29, following a weak demand in Treasury auctions.
  • Low: 4.22% on June 14, after favorable CPI and PPI inflation reports.

Investors are hesitant to push yields below 4.25%, a level aligned with expected inflation of 2%-2.5% and the term risk premium.

Friday morning, Headline PCE inflation printed unchanged (0%) for May and +2.6% year-over-year.  Core PCE (without food and energy prices) printed at +0.1% month over month, and +2.6% for the year.  The PCE numbers confirmed the CPI and PPI inflation prints earlier in the month and is the first step for the case for the Fed to start cutting Fed Funds rates.    

See above, Monthly Core PCE for the past few months; annualizing May’s print gets us to an annual inflation rate of 1.2%. Game over, right? Not so fast (unfortunately). Recall, with the bond-friendly Core PCE prints during the last 3-months of 2023, in December/January, 10-year Treasury yields moved to a 3.80-handle and the forward curve implied over 1.50% in Fed Funds rate cuts during 2024.  Then, the inflation prints for the first 3-months of 2024 moved yields higher and the Fed monetary policy remained restrictive. Given this recent history, bond investors probably stay suspect and will want to see a follow-through of the data before rates move substantially lower.

Currently, the Fed is holding off on rate cuts, awaiting further evidence of progress toward its 2% inflation target or a notable weakening in the labor market. The overnight Fed Funds rate remains high at 5.25%-5.50%, and while May's inflation data is promising, it's not sufficient for a rate cut at the upcoming July FOMC meeting. A 0.25% cut could be in play for September if bond-friendly data continues. Meanwhile, the Fed is expected to maintain a data-dependent stance without signaling any imminent policy changes, especially with the unemployment rate steady at 4% and strong job growth.

Upcoming Economic Calendar
This week’s economic data includes a series of employment figures, highlighted with the June US Employment Report (non-farm payroll and unemployment rate) on Friday (7/5).  The market consensus is for +190,000 new non-farm payroll jobs (versus last month’s job growth at +272,000) and for the unemployment rate to remain at 4%, the same as last month.  The bond market will also focus on the Average Hourly Earnings print on Friday (7/5), a gauge of wage inflation; the consensus estimate is for an increase of +0.3% month-over-month (vs. last month’s +0.4% print).  We will also see a JOLTS Job openings report on Tuesday (7/2) and an ADP Jobs report and Weekly Initial Jobless Claims on Wednesday (7/3).    

Agency Securities Spreads
Fannie Mae 10/9.5 pass-through rates are currently at 0.53% over 10-year Treasuries, up 3 basis points since last Monday. Agency CMBS dealers are holding near-record trading inventories, contributing to spread widening. Spreads remain within 5 basis points of their low over the past year. For context, spreads had peaked at over 1% in March 2023 due to reduced demand from regional banks following the Silicon Valley Bank and Signature Bank insolvencies; during 2021, with the easy money policy and near-zero interest rates orchestrated by the Fed, spreads had narrowed to just 5-10 basis points.

GN/FHA Mortgage Spreads
GN pass-through rate spreads are quoted at 0.83% over 10-year Treasuries, improving by 2 basis points since last Monday. GN spreads also remain within 5 basis points of their yearly low. Historically, GN spreads have ranged from 0.44% in June 2021 (with the Fed's easy monetary policy), to 1.42% in June 2023 (with regional bank illiquidity post-SVB).

Ginnie Mae REMIC accumulators (Wall Street dealers) buy nearly all individual GN/FHA loans from lenders like Greystone, repackaging them into sequential-pay Ginnie Mae REMIC securities. An upward-sloping yield curve typically enhances the value of these structures, benefiting both borrowers and dealers. However, the current inverted yield curve has kept spreads wide. As the Fed begins to lower short-term rates and the yield curve normalizes, we should see improved GN spreads with extra value in the sequential-pay REMIC structure.

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