Top of the Street: Flip that yield curve

The Fed may allow inflation to temporarily run above 2% in the future to counter episodes of near-zero rates and low inflation, a recipe for inverted yield curves. A roadmap for tapering. More on mortgage lending, CLOs, auto ABS. Contributions from the Brookings Institute, DB, GS, NBER and, of course, Milepost.

Markets: Flip that yield curve
US rates have dipped toward their lowest levels of the year in the last few weeks as first healthcare and then tax cuts and infrastructure spending have looked in doubt. But with the Fed still on the move, expect some reversal. US 10-year rates should rise a bit for the rest of the year but still stay below 2.75%. The real action is on the short end of the curve as the Fed plays with a mix of hikes and portfolio tapering. The yield curve should flatten. Over the longer run, the US could see flat or even inverted curves much more frequently than in the past. That’s the clear implication of a new line of thinking getting traction at the Fed and described last week in posts from former Fed Chair Bernanke here and here. To counter the risk of zero rates and low inflation in the future, the Fed may need to let inflation temporarily run above target to get an average 2.0%. Short rates would have to compensate for the higher inflation, rising and inverting the yield curve much more often. (Brookings Institute, Milepost).

Markets: A roadmap for tapering
The Fed will likely announce a tapering of the SOMA portfolio in December, Goldman Sach’s estimates, tapering 10% a month until reinvestment reaches zero. Both Treasuries and MBS should roll out of the Fed portfolio through mid-2020, according to the firm, with the Fed reinvesting in Treasuries after that and allowing only MBS to keep rolling off. Tapering alone should push up 10-year rates by 10 bp to 15 bp a year. See Goldman Sachs, US Economics Analyst: Q&A on Balance Sheet Normalization, 14 Apr 2017. (GS, Milepost).

Banking: Mortgage lending heads back into the shadows
Non-banks have nearly tripled their share of residential mortgage lending in the last decade with their take of 2007-2015 originations rising from 14% to 38%. The biggest non-bank gains have come among borrowers with weaker credit, minority borrowers and borrowers refinancing their loans, according to a new study by researchers from the University of Chicago, Columbia and Stanford. The drivers: new regulatory burdens on banks and the technology advantages of non-banks. In fact, because new technology often makes getting a loan more convenient, some non-bank lenders actually can charge higher rates. The new study is here. (NBER, Milepost).

Markets: The continuing CLO refi wave
March set a record with more than $20 billion of CLO refinancings, according to Deutsche Bank, and April could break it. CLO refinacings have already crossed $11 billion in the first half of April. Tight CLO debt spreads are giving CLO equity managers incentives to squeeze a few more dollars out of funding costs. Two refinancing have priced this month for deals just about to begin amortizing their debt, with the relatively short AAA funding pricing below LIBOR+100 bp. Many of these classes originally priced at L+150 bp or wider. See Deutsche Bank, The Outlook in MBS and Securitized Products, 12 Apr 2017. (DB, Milepost).

Markets: Used car prices hit the skids
The average price of a used car dropped 0.5% in March, according to the Manheim Used Vehicle Value Index, although still edging up 1.3% over the last year. Used trucks (+6.7%), vans (+3.9%) and SUVs (+1.4%) appreciated the most year-over-year while compact (-0.9%), midsize (-1.6%) and luxury (-1.8%) cars fell. Weak used car prices have been feeding investor concerns about rising delinquencies in auto ABS and rising loan losses. See Deutsche Bank, The Outlook in MBS and Securitized Products, 12 Apr 2017. (DB, Milepost).