Top of the Street: Rates, credit cards, autos, commercial real estate and GDP flap in the wind

Hurricanes Harvey and Irma will have lingering effects on economic data and all the markets that rely on it. Contributions from DB, GS, JPM, the Fed and Milepost.

Markets: Consensus on rates drifts lower
The flash of US 10-year rates at 2.01% last week has rattled the Street consensus that rates will rise significantly before the end of the year. JPMorgan revised its 10-year expectations to 2.40% last week, and Deutsche Bank continues to argue that low rates are here to stay. The low implied path of fed funds embedded in the futures market—suggesting that the next full 25 bp hike in fed funds will only come in 4Q18—also suggests that rates have limited room to rise. Tensions over Korea, the US debt ceiling and a government shutdown helped drive rates lower in August, and concerns about the economic impact of Hurricanes Harvey and Irma may have driven rates toward 2.00%. With the worst-case storm scenarios unfulfilled, rates have risen a bit. Low inflation and low potential growth still limit a further rise in rates. The rate on 10-year notes may run below 2.50% well into 2018. See Deutsche Bank, Global Market Strategy, 8 Sep 2017. (DB, Milepost).

Markets/economy: Hurricane season for the Fed and GDP
The GDP impact of hurricanes Harvey and Irma may kick the Fed’s next rate hike further down the road. Harvey already stands to become the second most costly US natural disaster since World War II, surpassed only by 2005’s Hurricane Katrina. The bill for Irma will become clearer this week, but early reports from Florida show extensive damage. US natural disasters have initially suppressed GDP followed by a compensating rebound. Harvey should cut 3Q17 GDP by 0.8 percentage points, according to Goldman Sachs, followed by a rebound in 4Q17, 1Q18 and 2Q18. Irma should also initially depress GDP with a rebound in 2018. The Beige Book has noted disruptions from Harvey, and New York Fed President Bill Dudley suggested last week that Hurricane Harvey could reduce activity this year and boost growth in 2018. Irma should add to the Fed’s concern and the likelihood that the Fed will delay its next hike. Although the Fed has hinted at a December hike if inflation data rebounds, the fed funds futures market does not expect a full 25 bp hike until 4Q18. See Goldman Sachs, Hurricane Handbook: Natural Disasters and Economic Data, 9 Sep 2017. (GS, Milepost).

Markets: Harvey and Irma hit credit card and auto ABS
Texas contributes 6% to 10% of the debt backing outstanding credit card ABS with Florida contributing 5% to 9%. And when it comes to auto ABS, Texas and Florida contribute 10% to 12% of the debt. The jolt to the economies in those states could temporarily drive up defaults. The impact on auto ABS will also depend on the recovery value of the cars, which will depend, in turn, on proceeds from insurance. See JPM, US Fixed Income Markets Weekly: ABS, 8 Sep 2017. (JPM, Milepost).

Markets: Harvey hits commercial and multi-family CMBS
Around $29 billion or 3% of all loans backing outstanding CMBS come from the 29 Texas counties designed by the US government after Hurricane Harvey as major disaster areas. The storm hit properties backing agency CMBS much more than private CMBS. “This isn’t surprising given that Agency CMBS collateral is entirely multifamily and therefore more numerous in areas outside of Houston,” JPMorgan analysts write, “while private label has larger exposures to large commercial real estate properties that can have higher concentrations in urban centers.”  The impact of the storm will depend on the insurance carried by each property, including flood insurance, business interruption insurance and ‘all risk’ insurance, which covers building contents. Even through Fannie Mae and Freddie Mac will cover losses in their CMBS, loans that remain delinquent for four months often are bought out of the pool by the agency at par. See JPMorgan, US Fixed Income Markets Weekly: CMBS, 8 Sep 2017. (JPM, Milepost).

Markets: Sen. Warren calls out the VA troops
Ginnie Mae MBS have suffered in recent years from sudden bursts of refinancing in loans guaranteed by the Veterans Administration, and Sen. Elizabeth Warren (D-MA) last week sent a letter to Ginnie Mae demanding an explanation. The aggressive refinancing has hurt pricing of Ginnie Mae MBS and raised mortgage rates for all eligible borrowers. The aggressive refinancing tends to come from a handful of originators—Freedom, Lakeview and NewDay especially—that seem to originate loans with relatively high interest rates and then refinance the loans months later – even without any significant drop in broader mortgage rates. Although Ginnie Mae’s rules forbid lenders for making these kinds of arrangements, brokers and other third parties may be orchestrating the business. Sen. Warren asked for an answer by Sep 22, which may prompt Ginnie Mae proposals to address the problem. Any new measures by Ginnie Mae could lift the price of its securities. See JPMorgan, US Fixed Income Markets Weekly: MBS, 8 Sep 2017. (JPM, Milepost).

Banking: Finding an optimal portfolio to satisfy bank liquidity rules
Large US banks built up sizable stockpiles of reserves before the 2014 deadline for meeting new bank liquidity rules but have shifted into Treasury debt and agency MBS since. The shift in asset mix almost certainly depends on each bank’s risk appetite, conservative banks holding more reserves and aggressive banks holding more MBS. Fed researchers last month released a study of the shifting bank asset mix used to meet bank liquidity rules and estimated an optimal mix depending on bank risk tolerance. Most importantly, the study suggests that when the Fed starts unwinding its QE portfolio and drawing down reserves, only the most conservative banks might be forced into the Treasury or MBS markets to maintain their Liquidity Coverage Ratio. The Fed paper is here.