The Fed and Ginnie Mae talk and act on MBS, the boom in apartment building slows, China, Europe and Japan play out in the wings. Contributions from GS, JPM, MS, DB.
Markets: The Fed hand in MBS
A string of recent comments from the Fed and others may point to a permanent role for the Fed in agency MBS, according to Goldman Sachs. The manager of the NY Fed’s open market desk, Simon Potter, last week gave the Fed high marks for including agency MBS in QE. His comments follow former Fed Chair Bernanke’s recent case for keeping the Fed’s portfolio close to its current size. And St. Louis Fed President Bullard and Boston Fed President Rosengren both mused recently on new ways to use the Fed portfolio. Historian Niall Ferguson a few years ago reviewed 100 years of central bank balance sheets and found no examples any active sales of long-term assets. Goldman still expects the Fed to taper reinvestment starting in mid-2018 but possibly never stop entirely, giving the Fed a permanent position in MBS. See Goldman’s Fed’s Balance Sheet: Larger for Longer, 21 Oct 2016. (GS, Milepost).
Markets: Ginnie Mae fixes a VA problem
Ginnie Mae last week moved to stop mortgage originators from making new Veterans Administration loans and then refinancing them within months after putting them in new Ginnie Mae pools, taking money out of the pocket of investors in the process. Starting in February, any refinanced VA loan will have to show at least six payments on the old loan before it can go into a Ginnie Mae I or a Ginnie Mae II multi-issuer pool. Some originators had created VA loans with high coupons and sold them at a premium. Prepayment speeds on VA loans from originators New Day and Freedom had then jumped to 80 CPR within three months of securitization. The originators likely then sold the new loan. The new rules may push speeds higher as some originators rush to beat the February deadline. After the deadline, speeds on newer VA loans could run slow for the first six months before spiking afterwards. Prices on Ginnie Mae TBA and specified pools should show the impact. See JPMorgan, US Fixed Income Weekly, 21 Oct 2016. (JPM, Milepost).
Markets: Inflection in apartment building
Falling US homeownership rates and rising demand for apartments has driven a boom in multi-family building since 2008, but it may be losing momentum. Vacancy rates have ticked up lately, rent growth has slowed a bit, the gap between units completed and units bought or rented has opened noticeably this year. Multi-family construction as a share of GDP has jumped from 9 bp in 2011 to 32 bp this year, not far from the 2006 peak of 38 bp. Homeownership looks unlikely to rebound quickly, but the long timeline to plan, fund and build apartments has always risked running ahead of demand at some point. We may be getting there. See JPMorgan, US Fixed Income Weekly, 21 Oct 2016. (JPM, Milepost).
Markets: Boring is better
A lot of good research shows that some of the sleepiest sectors of fixed income produce some of the best returns – after accounting for risk. Although not a sleepy sector, the rule seems to apply to Fannie Mae and Freddie Mac’s programs of credit risk transfers. The safest bonds issued through the programs, the M1 classes first in line to get principal and last to absorb losses, have towered over the riskier bonds, according to the latest work from Morgan Stanley. The Sharpe ratio on M1s has run at least double the level of the M2 or M3 classes and the level on IG corporate debt. This replicates the findings first published by Deutsche Bank in mid-2015. See Morgan Stanley’s CRT: Looking Sharpe, 20 Oct 2016. (MS, Milepost).
Markets: Watching China
China is in the midst of a dramatic loosening in credit. In January 2016, its banks created more credit that the entire US financial system has ever done in any single month, according the Deutsche Bank. Debt as a share of China’s GDP has jumped 17% so far this year, more than it did from trough-to-peak in 2000-2007. In the last 18 months, debt jumped by 42% of GDP, greater than the credit pulse injected in 2008-2009. Local governments, households, private enterprise and state-owned enterprise are all adding leverage. A sign of strength or weakness? See DB’s US Credit Strategy, 19 Oct 2016. (DB, Milepost).
Markets: Watching Europe
The ECB looks likely extend and expand its QE program when it ends in March, according to Deutsche Bank. The bank projects that the current QE program, if extended, will run out of eligible bonds in the large and liquid German market by June 2017. The ECB could tweak the current limits on the share of an issue it can own (33%), the yield (greater than -0.40%) or the GDP-weighted allocation. That could create enough eligible supply of bunds to run anywhere from late 2017 to early 2019. The European Central Bank last week said little about tweaks to its effort to revive the European economy, but the hints probably come when it meets next in December. See DB’s US Credit Strategy, 19 Oct 2016. (DB, Milepost).
Markets: Watching Japan
Markets have moved significantly in Japan since the Bank of Japan decided a month ago to target yields along its entire domestic yield curve. Japanese equities have led global markets, the Yen has weakened after generally strengthening earlier this year, the curve has steepened and market-implied inflation has moved up. While the BoJ is in uncharted territory on monetary policy, results so far seem consistent with its goals. See DB’s US Credit Strategy, 19 Oct 2016. (DB, Milepost).