Top of the Street: The Fed weights reinvestment, Treasuries run deep, CRE runs scared of retail

The Fed has started prepping the market for an end to portfolio reinvestment, Treasury liquidity improves, CRE widens on retail fears, ABS watches subprime credit crumble and more. Contributions from GS, JPM, MS, Nomura and, of course, Milepost.

Markets: The Fed weighs an end to reinvestment
The Fed looks like it may be getting more comfortable with letting its investment portfolio start winding down later this year. Since the March FOMC meeting, seven Fed governors have spoken about a smaller balance sheet. Kashkari (Minneapolis), Mester (Cleveland) and Williams (SF) in particular have pointed to starting later this year. Goldman Sachs speculated recently that the Fed would start the process before the terms for Chair Yellen and Vice Chair Fischer end in early 2018 to reduce market uncertainty about the path taken by any new appointees. Former Fed Chair Bernanke has written that Fed speeches simply continue FOMC policy debates by other means. From that, it sounds like a definitive direction for the portfolio will likely be set this summer. See Nomura’s Agency MBS Basis: Is the Market Being Complacent? 24 Mar 2017, and Goldman Sach’s US Economics Analyst: Balance Sheet Runoff: Sooner, Slower, Safer, 18 Mar 2017. (GS, Nomura, Milepost).

Markets: The Treasury market runs deep
Nothing beats the US Treasury market for liquidity, and its depth lately has even improved. Average daily trading volume has jumped from $480 billion in the first half of last year to $545 billion in the last six months. The equivalent of slightly less than 5% of the market trades daily. Dealers’ share of auctions is rising. And even though 50% of trading volume goes through the top quintile of dealers, that share is smaller than the top quintile in agency debt (52%), MBS (76%), credit (72%) and TIPS (58%). See JPMorgan’s US Fixed Income Markets Weekly, 24 Mar 2017. (JPM, Milepost).

Markets: CRE runs scared of retail
While pricing in the cash CMBS market has been stable lately, the CMBX derivatives market has signaled concern. Spreads on BBB- and BB credit default swaps widened between 10 bp to nearly 30 bp in the last week, the same week that Sears disclosed ‘substantial doubts’ about its ability to survive. CBRE, a global commercial real estate operator, also convened a conference call to discuss retail. CBRE argued that while traditional retail is under pressure from e-commerce, e-commerce providers themselves have been moving from ‘clicks-to-bricks.’ The market also has to brace itself for the coming debate on tax reform. If reform raises the cost of imports, that puts further pressure on retail, which is a net importer. See JPMorgan’s US Fixed Income Markets Weekly, 24 Mar 2017. (JPM, Milepost).

Markets: ABS wrestles with rising subprime auto delinquencies
Delinquencies (4.69%) and defaults (11.96%) in subprime auto ABS have started approaching levels last seen in 2009 despite strong employment, high consumer confidence and low overall levels of consumer debt. And losses on defaulted subprime auto loans have recently breeched 60%, also near 2009 levels. Chalk it up to loosening lending standards from 2011 through 2016 and an average FICO that fell 30 points. The real culprit may be a rising share of issuance with average FICO below 550. The share of auto ABS origination from deep subprime issuers has climbed from 5% to 32%, creating a large set of loans leveraged on the direction of the economy and the health of the auto industry. See Morgan Stanley’s Subprime Auto: Digging into Delinquencies (Part I), 24 Mar 2017. (MS, Milepost).

Markets: Corporates defy expectations
Issuance of corporate debt will tank as tax reform takes away the interest expense deduction, and spread volatility will spike as new policy overturns old. At least that was the expectation of analysts at the start of the year. Instead $344 billion in issuance has already set a new record for quarterly IG issuance and spread volatility is at a 5-year low. The latest prediction has become, of course, more of the same. As apparently the Danish, Mark Twain and Yogi Berra have said, it’s hard to make predictions, especially about the future. Lots of analysts these days feel the same way. See JPMorgan’s US Fixed Income Markets Weekly, 24 Mar 2017. (JPM, Milepost).

Markets: CMBS loves New York
CMBS loves New York, at least when it comes to deals built on a single asset or a single borrower. Single Asset/Single Borrower CMBS deals have 47% of their principal just in New York City. Agency CMBS, which includes only multi-family borrowers, has only 2% exposure to the Big Apple. The top five states in agency CMBS – CA, TX, NY, FL and CO – provide less than 50% of total principal for agency CMBS-K deals. Goldman Sachs thinks the 12% exposure to Texas is worth monitoring, however, since the impact of the 2014 plunge in energy prices is still working through the system. See Goldman Sachs The Mortgage Trader, 24 Mar 2017. (GS, Milepost).