By Serafino Tobia, Director of Agency CMBS Trading and Portfolio, Greystone
US Treasuries
The 10-year Treasury yield is at 3.85% as of Friday, 8/2, gapping lower today after a US employment report for July that printed just 114,000 new jobs - significantly weaker than expected. We’ve come a long way over the past couple months; recall 10-year yields were at 4.62% just over two months ago (5/29). Investors and traders are now front running the notion that inflation is on a clear path towards the Federal Reserve’s 2% inflation target and that interest rate cuts by the Fed are about to follow in September. For 10-year rates to move materially lower from here, we will need further bond-friendly inflation data and/or data that shows a further softening of the labor market and the economy. There is a Wall Street axiom that applies here – “The trend is your friend, until it ends.” In other words, it may well be time to take advantage of where rates have moved to already.
Soft Landing Economic Data and Fed Funds Rate Cut in September
It looks like the economy is on a trajectory to a soft landing – inflation is moving incrementally towards the Fed’s 2% target and the economy has remained firm with solid GDP growth and only a moderate slowing of job growth and incremental increases in the unemployment rate.
Inflation
In July, the CPI and PCE inflation data added to the case for the Fed to start cutting Fed Funds rates. Headline PCE inflation for June printed +0.1% for the month and +2.5% year-over-year. Core PCE (the Fed’s preferred inflation gauge without the more volatile food and energy prices) printed at +0.2% month over month, and +2.6% for the year. Core PCE month-over-month has averaged +0.19% over the past three months (April-June); that’s +2.28% annualized inflation.
Production and Employment
The second quarter Gross Domestic Product (GDP) printed last week – the markets were expecting +2% (annualized growth) but GDP came in at +2.8% growth, nearly a full point above market consensus. That is after Q1 GDP growth posted at +1.4% and 2023 Q3 and Q4 posted at +4.9% and +3.4% respectively. In other words, production is slowing but only incrementally. The US employment report for July was published Friday (8/2), the non-farm payroll added just +114,000 new jobs in July (versus the +175,000 market consensus estimate and the previous month’s print at +206,000). The unemployment rate moved to 4.3%, higher by 2/10ths of a percent.
Rate Cuts in September
The Federal Reserve FOMC met this past Tuesday and Wednesday (July 30-31) and they decided to keep the overnight Fed Funds rate restrictive (5.25%-5.50% range). However, after the employment report on Friday (8/2) and significantly weaker job growth, market participants are convinced that the Fed will start Fed Funds rate cuts at the next FOMC meeting on September 17-18 with possibly a cut of 0.50%. Before we get to the September FOMC meeting, we have to wade through the inflation data for July and August, and there’s no guarantee that inflation doesn’t reignite. Recall, after the bond-friendly inflation prints during the last three months of 2023, 10-year bonds traded as low as 3.79% at the end of December (12/27/2023). However, we then experienced higher inflation prints in the first quarter this year which dashed hopes for rate cuts at that time and interest rates moved higher.
In the near-term, for 10-year Treasuries to move materially lower from here, we need inflation prints to continue to cooperate and/or the economic data to weaken further. After the first Fed Funds rate cut, the bond market will focus on how aggressive the Fed will be to normalize interest rates. The forward curve implies rate cuts of 1% by year-end 2024 (a 0.50% cut at the FOMC meeting on 9/18 and another 0.25% at the FOMC meetings in November and December). Beyond that, what looks like a soft landing for the economy could be the first sign of a recession and that would push the Fed to normalize interest rates more quickly.
Agency Multifamily Securities Market Spreads
The market spread for benchmark 10-year Fannie Mae DUS securities and Freddie Mac K Series securities is currently in the context of 50 basis points over 10-year Treasuries with some variation based on structure, CRA qualified and loan-to-value and debt service coverage (note – the full rate stack for the mortgage rate includes the related Treasury rate, market spread and Agency guarantee and servicing fees).
Agency CMBS dealers are holding near-record trading inventories, contributing to an incremental widening of spreads. Despite this, 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 following the Silicon Valley Bank and Signature Bank insolvencies, compared to just 5-10 basis points in 2021 during the Fed’s easy monetary policy response to the COVID pandemic.
35-year Ginnie Mae/FHA Multifamily Spreads
35-year Ginnie Mae investor rates are currently about 0.85% over 10-year Treasuries. These spreads also remain within 5 basis points of their low over the past year. Historically, GN spreads have ranged from 0.44% in June 2021, under the Fed's easy monetary policy, to 1.42% in June 2023, amid regional bank illiquidity post-SVB. Ginnie Mae REMIC accumulators buy nearly all individual GN/FHA loans from lenders like Greystone, repackaging them into sequential-pay 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 and value in the sequential-pay REMIC structure.
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