Top of the Street: How bad news becomes good news for rates and credit

Top of the Street: How bad news becomes good news for rates and credit

Slow growth, low inflation and a little help from the world’s central banks should keep rates low. But when does a lackluster economy help credit?  When nothing else offers much yield. Good stuff from JPM, DB, CS, Goldman Sachs.

Markets: Rate expectations
Slow growth, little inflation, the response of the world’s central banks and lately the possibility of fiscal stimulus.  Rates keep dancing to these tunes. The influence of global QE in particular led JPMorgan last week to revise its expectations for year-end US 10-year yields from 1.70% to 1.55%, well below forward rates. But that still looks sunny compared to Deutsche Bank’s expectation of 10-year rates at 1.25% -- and ranging between 0.95% to 1.55% -- based on views similar to Larry Summers’ case for secular stagnation. Give DB kudos for highlighting potential fiscal stimulus in Japan following elections there, an effort that could temporarily push up yields globally on expectations of faster growth. But DB is skeptical, arguing that saving by the private sector would offset government spending. DB studies this possibility and finds that it holds in the US and Japan. See JPMorgan’s US Fixed Income Markets Weekly, 15 Jul 2016, and Deutsche Bank’s US Fixed Income Weekly, 17 Jul 2016. (JPM, DB, Milepost).

Markets:  A sticky summer in MBS
The latest drop in Treasury rates highlights the lag before it reaches mortgage borrowers. JPM focuses on tight MBS valuations and sticky primary rates that have fallen by only 50% of the move in Treasuries. Chalk it up to limited capacity, especially since purchase activity has soaked up a lot of loan officers’ time. Meanwhile, Fannie Mae and Freddie Mac’s regulator updated progress toward getting conventional MBS into one single security for TBA, a change still on track to come to market in 2018. And FHA’s went to Capitol Hill last week to explain a change to the Distressed Asset Stabilization Plan, which now allows non-profits to bid on 5% of a pool and win as long as they meet the reserve price. See JPMorgan’s US Fixed Income Markets Weekly, 15 Jul 2016. (JPM, Milepost).

Markets: Side effects in CMBS from aggressive CRE portfolio lending
An aggressive bid for commercial real estate from banks and insurers is having a side effect on the CMBS market. JPM points out that the share of CMBS collateral backed by hotels has jumped from 26% in 1H16 to 32% in July, and retail from 16% to 19%. These generally are riskier credits, which may not fit portfolio lenders. Hotel revenue growth has slowed a bit, according to Credit Suisse. The OCC flagged CRE concentration at banks a week ago in releasing its latest Semi-Annual Risk Perspective. And last week JPM reported an 18% YoY jump in CRE lending, and Wells Fargo an 8% jump. See JPMorgan’s US Fixed Income Markets Weekly, 15 Jul 2016, Credit Suisse’s CMBS Market Watch, 14 Jul 2016, Goldman Sachs’ The Mortgage Trader, 15 Jul 2016. (JPM, CS, Milepost).

Markets: ABS gets the call
Last week saw the most weekly ABS issuance, $10.5 billion, since the end of the financial crisis but spreads nevertheless held their ground, according to most of the Street. The calendar included a $1.1 billion inaugural securitization of installment payments on phones sold by Verizon. Moody’s expects this market to grow by more than $20 billion in the next two years. (Milepost).

Markets: Tighter corporates but signs of weaker credit
Spreads on IG credit continue to tighten, and JPMorgan thinks there’s more to come. Although 31% of JPM’s global bond index has a negative yield, only 1.7% were issued that way. As bonds with negative yields mature, some of those dollars should be lured into the US. Financials continue to fall behind the rest of the market. For banks, Brexit, low reinvestment yields, TLAC supply and declining M&A are all having effect. Deutsche Bank looks beyond the latest market action and sees warning signs. “This rally has taken place despite a growing body of evidence that the credit cycle has most likely turned the corner in recent months,” write Oleg Melentyev and Daniel Sorid. They expect defaults in HY to start rising. See JPMorgan’s US Fixed Income Markets Weekly, 15 Jul 2016, Deutsche Bank’s US Credit Strategy, 15 Jul 2016. (JPM, DB, Milepost).