Top of the Street: On towards flatter yields, upcoming in politics and a $400 billion sale to start the year

A flatter yield curve, contentious politics, a $400 billion corporate sale, a tax gift for REITs and more bad news for retail. And that’s only the first week of the year. Contributions from CoreLogic, CS, GS, JPM and Milepost).

Markets: On towards flatter yields
Flatter. And maybe a little higher. That should be the direction for US rates. Tax reform should give a small lift to growth this year and, possibly, inflation. The bump in deficit spending from tax cuts should also help lift 5-year and shorter yields. The December FOMC minutes signaled a Fed on track to tighten between two and four times this year. The spread between 2- and 10-year yields since December 20 has dropped by 14 bp. Look for it to go to zero this year and for 10-year rates to range between 2.25% and 2.75%. See JPMorgan, US Fixed Income Markets Weekly, 5 Jan 2018. (JPM, Milepost).

Markets/economy: Upcoming in politics
On the political agenda for the foreseeable future: First, federal spending authority, which expires January 19 and has become tangled up in the debate over deferred action for childhood arrivals (DACA) and an $18 billion administration request for a border wall. Second, the US debt limit, which will need to be raised by March. Third, US deficits, which should rise with tax cuts and likely new fiscal spending and approach 3.7% of GDP this year and 5.5% by 2021. Fourth, infrastructure. Fifth, technical corrections to tax reform. And beyond these items come tweaks to Obamacare, financial regulations, GSE reform, international trade, and the looming 2018 midterm elections. See Goldman Sachs, US Economics Analyst: The 2018 Political Outlook: More Stimulus and New Trade Risks Ahead of the Midterms, 6 Jan 2018. (GS, Milepost).

Markets: A $400 billion sale to start the year
The first week of the year brought more than $400 billion in selling of longer corporate debt likely by Taiwan insurers, according to JPMorgan. Taiwanese investors had a 1-time opportunity to reclassify investments from old to a new accounting categories starting Jan 1, 2018, and apparently decided to take some gains before reinvesting. The new categories give Taiwan investors a little more flexibility to trade their accounts, but the selling doesn’t necessarily signal a material change in investment strategy. Taiwan insurers invest heavily in US corporate debt, callable agency debt and agency MBS. See JPMorgan, US Fixed Income Markets Weekly, 5 Jan 2018. (JPM, Milepost).

Markets: A tax gift for MBS REITs
December’s tax reform includes a gift for REIT investors, including those that invest in MBS. Investors will be able to deduct 20% of qualified REIT dividends. An investor with a 37% marginal tax rate, for example, consequently pays only 29.6%. For a REIT paying a 10% dividend, that’s a 74 bp gain in after-tax income. The REIT provision hasn’t had a clear effect on REIT stocks so far, but a lift to the sector could help REITs raise equity as they did in 2017 and become better buyers of MBS. The new benefit now makes REITs much more efficient than mutual funds as a way to hold MBS risk. See JPMorgan, US Fixed Income Markets Weekly: Agency MBS, 5 Jan 2018. (JPM, Milepost).

Markets: Retail rolls over CMBS again
Sears and Macy’s announcement that week that they would close more stores has put a range of CMBS deals at risk. Sears announced it would close 39 Sears stores and 64 K-Mart stores sometime between early March and April. Macy’s announced 11 closings. The Sears closings affect nine loans backing CMBS deals, including one loan that makes up 41% of the loan pool behind a 2006 CMBS deal. The Macy’s closings affect three CMBS deals. This is the latest round of bad news to hit CMBS as e-commerce continues to hurt bricks-and-mortar retail shopping, with loans to mall operators most at risk. Credit Suisse expects retail closings and bankruptcies to continue, weighing on rents and vacancy rates. See Credit Suisse, CMBS Retail Outlook: transformation accelerating, 4 Jan 2018, and Credit Suisse, CMBS Loans in the News: Another 64 Kmart and 39 Sears are closing, 4 Jan 2018. See also JPMorgan, US Fixed Income Markets Weekly: CMBS, 5 Jan 2018. (CS, JPM, Milepost).

Markets: Single-family rents slow
Rents on single-family houses rose 2.7% year-over-year through October, according to CoreLogic, down from a peak pace of 4.4% in February 2016. The most pronounced slowing came in the most expensive rentals. Trends in rents also varied widely across different markets. Las Vegas saw single-family rents rise 4.6% year-over-year through October, while rents in Miami dropped 1.3%. The CoreLogic post is here. (CoreLogic, Milepost).

Top of the Street: A march, a mystery, a BEATing on taxes and more

The Fed takes a dovish final bow. LIBOR jumps as banks temporarily trim lending. Tax reform could BEAT foreign banks. DQs rise in PR. And a read on politics and economics. Contributions from Barclays, JPM, MS, NY Fed and Milepost.

Markets: The Fed marches on. Cautiously.
The Fed last week hiked as expected and raised the cap on monthly portfolio runoff, but concern about inflation led it to signal only three more hikes in 2018. Some analysts had expected four. The Fed’s had an upbeat take on both the labor market and economy seemed less convinced that inflation will move closer to the 2% target. Core inflation for November came in at a weak 0.12%. Core PCE inflation is likely to come in this week at a year-over-year pace of 1.5%. Chair Yellen also so made some notable comments that future yield curves could be flatter or more frequently inverted than in the past. See JPMorgan, US Fixed Income Markets Weekly: Economics, 15 Dec 2017. See also Morgan Stanley, Global Interest Rate Strategist, 15 Dec 2017. (JPM, MS, Milepost).

Markets: LIBOR’s mysterious rise
The cost of short-term funding almost always rises at the end of each quarter as banks trim lending to reap a wide range of benefits from a smaller balance sheet, but the rise this quarter is especially sharp. LIBOR and other funding rates have jumped even after accounting for the recent Fed hike, and sharp cuts in lending from the eight US global systemically important banks may be to blame. These banks will have to set aside a capital surcharge in 2019 based on their balance sheet at the end of 2017. The capital surcharge depends on a score that includes size, complexity, international activity, connections to the rest of the financial system and short-term wholesale funding. Many of these banks are on the edge of scores that would push up their capital surcharge by 50 bp, so there is clear incentive to pull back. Reducing funding is one flexible way. Steady demand for funds with falling supply has pushed up rates, but that will likely reverse after the New Year. See JPMorgan, Making sense of Libor’s mysterious rise, 14 Dec 2017. (JPM, Milepost).

Markets/banking: Tax reform could BEAT foreign banks
Measures in the pending tax reform bill designed to stop a form of tax arbitrage could hurt foreign banks’ business in the US. The measure, the Base Erosion Anti-Abuse Tax or BEAT, targets the strategy of having a parent in a low-tax country make a loan to a US affiliate that allows the affiliate to deduct interest and reduce taxable income. Under the Senate version of BEAT, a bank’s gross interest payments to a foreign parent or affiliate would trigger an additional tax. The Institute of International Bankers or IIB, representing foreign banks in the US, has argued for the House version, which would tax the smaller net interest payments to foreign affiliates. The IIB argues that the Senate version is punitive and would hurt foreign bank lending, especially in the repo market where eight of the 10 largest lenders are foreign banks. JPM, US Fixed Income Markets Weekly: Short-Term Fixed Income, 15 Dec 2017. (JPM, Milepost).

Markets/economy: Puerto Rico’s homeowners roll further into delinquency
While an initial wave of mortgage delinquencies after Hurricane Maria appears to have peaked, a rising share of Puerto Rico’s homeowners are rolling further past due. The share of Puerto Rico loans running 30 days delinquent surged from less than 5% before the storm to 22% in October before dropping to 9% last month. Loans running 60 days delinquent jumped from 5% in October to 16% last month. And loans 90 days delinquent jumped from 3% before the storm to 7% last month. This is all based on Ginnie Mae data. Tax reform also may add to the pain. Both House and Senate versions included a foreign import excise tax that would apply to Puerto Rico manufacturers exporting to the US. That could squeeze the island’s economy. See JPM, US Fixed Income Markets Weekly: Agency MBS, 15 Dec 2017. See also Barclays, Municipal Weekly: Rate Hikes and Tax Cuts, 15 Dec 2017. (Barclays, JPM, Milepost).

Markets/economy: Politics shapes expectations but not economics
The last presidential election improved both Democrat and Republican expectations about household finances and the economy but had no detectable effect on actual spending so far, according to a newly released NY Fed study. Counties that voted Democrat generally had a more optimistic outlook before the election, but optimism in counties that voted Republican surged ahead after the election. Expectations have fallen since, especially in Republican counties. Nevertheless, “the election had little partisan impact on spending,” according the the NY Fed. The NY Fed study is here. (NY Fed, Milepost).

Top of the Street: Reasons for short rates to rise this week, banks stockpile liquid assets, Ginnie Mae disappoints

The Fed gets its last hurrah for 2017. Banks look liquid. Ginnie Mae looks weak. Contributions from JPM, MS and Milepost.

Markets: Lots of reasons this week for short rates to rise
The Fed should hike this week, and it has a 50% chance of using its dots to signal four hikes in 2018 instead of three. Also look for the Constitution Avenue crew to announce a drop in it’s portfolio by as much as $20 billion a month starting in January, up from $10 billion currently. The US debt ceiling, which Treasury hit last Friday, may also nudge up short rates. Treasury can use $286 billion in extraordinary measures to fund the government through March. But it also will need to issue a steady supply of bills. The curve should almost fully flatten by the end of next year. See JPMorgan, US Fixed Income Markets Weekly: Treasuries, 8 Dec 2017. (JPM, Milepost).

Markets/banking: Banks stockpile liquid assets
The biggest US banks hold more than enough liquid assets to meet current bank liquidity rules, according to recent filings, which should help them weather Fed tightening. The eight largest hold $2.37 trillion in high quality liquid assets or 124% of the amount needed to cover the cash expected to leave the bank in regulators’ stress scenario. Nearly 85% of the liquidity portfolio sits in reserves held at the Fed, US Treasury debt or Ginnie Mae MBS. Another 15% is held in Fannie Mae or Freddie Mac MBS and less than 1% in other assets. As the Fed let’s its portfolio run off and starts to draw down reserves, the banks seem to have a sizable cushion for meeting liquidity rules. See JPMorgan, US Fixed Income Markets Weekly: Agency MBS, 8 Dec 2017. (JPM, Milepost).

Markets: Ginnie Mae disappoints
MBS investors hoping that Ginnie Mae would solve its recent prepayment problems were disappointed last week, and prices on the most sensitive Ginnie MBS dropped 8/32s to 16/32s below Fannie Mae. The agency announced new measures to dampen speeds in new pools, but the measures looked light. Speeds in new Ginnie Mae pools have been rising quickly in recent years, and the agency in December 2016 stopped originators from pooling loans that went through a streamline refinance within their first six months. That only delayed the prepayments. Last week Ginnie Mae extended that rule to cashout refis starting April 1. The agency also will add prepayment performance to a scorecard it calculates for each issuer, but there’s no clear enforcement mechanism for poor scores. It will also limit the pooling of loans with rates well above average. Much of the problem seems to be coming from VA loans, but Ginnie Mae has left it to the VA to apply a tangible benefit or fee recoupment test to refinanced loans, and VA has provided no public guidance. See Morgan Stanley, Agency MBS Weekly, 8 Dec 2017. See also JPMorgan, US Fixed Income Markets Weekly: Agency MBS, 8 Dec 2017. (JPM, MS, Milepost).

Markets: Eight things you need to know to trade fixed income in 2018
If you missed last week’s summary of key themes in the Street’s annual 2018 outlook gaze into the future, see our post for Mon, 4 Dec 2017. It’s there, hundreds of pages reduced to a few bullets. Brought to you by Milepost.