Top of the Street: Taper talk, tax cuts, hot and cold MBS and more

The Fed has artfully signaled a start to tapering around the end of the year, and the Street is singing the chorus. Thoughts on tax cuts and tax reform in the aftermath of failed healthcare reform. Developments in MBS and CMBS and research from the Fed. Contributions from CS, GS, JPM, NY Fed, SF Fed and, of course, Milepost.

Markets: Hikes, tapers and other Fed adventures
Hike, hike, hike, taper. Pause. Hike again. That’s the path the Fed has started to signal after last Friday’s remarks by NY Fed President Dudley. The pause would give the Fed time to see the impact of tapering before putting on the boots again. The Fed will need to weigh the impact of tapering on rates, financial conditions and housing in particular. Dudley’s remarks, comments from other FOMC governors and Street research all point to tapering late this year or early next before Yellen’s term ends. This puts most of the rate action this year in the front end of the curve since the back end has already priced for low real rates and low inflation. The curve should continue flattening. See Morgan Stanley, Pricing the Pace of Rate Hikes, 7 Apr 2017. Barclays, Much ado about balance sheet, 7 Apr 2017. (Barclays, MS, Milepost).

Markets/economy: Tax cuts before tax reform
Sometime in the next month or so, Congress will pass a budget resolution for fiscal 2018 that will show whether policymakers aspire to tax cuts or tax reform. Cuts look more likely. The budget will instruct the House Ways and Means Committee to pass tax legislation and will specify a revenue target. A big targeted drop will tip toward tax cuts, a small one toward revenue-neutral tax reform. Given the failure of healthcare reform so far and other complicating issues – a possible government shutdown on Apr 29, the current US debt limit that could squeeze Treasury borrowing as soon as October and the competing priority of infrastructure spending – cuts look more likely. In fact, JPMorgan notes that some currencies and commodities are pricing the probability of tax reform at close to 0%. See Goldman Sachs, Tax Cuts are Easier than Tax Reform, 7 Apr 2017. See JPMorgan, What odds Congress passes a BAT (border-adjusted tax)?, 10 Apr 2017. (GS, JPM, Milepost).

Markets: A bumper crop in MBS
A surprising $100 billion rise in net agency MBS supply so far this year has left the Street scrambling to revise it forecasts. JPMorgan last week revised its projection from $150 billion to $275 billion. Chalk it up to banks’ decision to turn a larger share of loans into agency MBS, more cashout refinancing, stronger home price appreciation and more existing home sales. Going into 2018, a Fed decision to allow MBS to run off its portfolio could add another $100 billion to next year’s effective agency MBS supply. See JPMorgan, US Fixed Income Markets Weekly, 7 Apr 2017. (JPM, Milepost).

Markets: A hot bid for residential mortgage credit
The competition to take residential mortgage credit risk continues to heat up. The most recent Freddie Mac credit transfer, STACR 2017-DNA2, cleared at prices equivalent to a running annual guarantee fee of 39 bp, according to JPMorgan, well below the 59 bp fee collected on the loans directly from originators. The aggressive capital markets bid reflects a continuing scarcity of alternatives. The outstanding market of private MBS securitizations continues to shrink, dropping $45 billion so far this year. JPMorgan expects Fannie Mae and Freddie Mac to continue issuing into the capital markets bid. See JPMorgan, US Fixed Income Markets Weekly, 7 Apr 2017. (JPM, Milepost).

Markets: CMBS feels the stress
Besides the drumbeat of bad news about malls and other retail exposures in CMBS, spreads on new deals have started softening, too. All classes in the market’s newest deal, BANK 2017-BNK4, priced wider than guidance. Credit quality may be the issue. “While underwritten leverage levels are slowly trending higher,” Credit Suisse writes, “rating agency stressed LTVs (on new deals) have notably picked up.” One clear positive for CMBS is that old deals continue to mature and refinance faster than new deals come to market, shrinking the outstanding supply so far this year by $24 billion. See Credit Suisse, CMBS Market Watch, 6 Apr 2017. (CS, Milepost).

Back to school: A new normal for interest rates, changes in the yield curve
The SF Fed has led the way in making the case for persistent low rates and adds to the brief by arguing that falling expectations for growth have cut yields by 2% in recent decades and seem unlikely to reverse quickly. The SF Fed paper is here.  Periods where short- and long-term rates move in opposite directions have become far more common since 2000, a phenomenon that Greenspan once dubbed a ‘conundrum,’ according to a NY Fed report here. (SF Fed, NY Fed, Milepost).