Top of the Street: On towards flatter yields, upcoming in politics and a $400 billion sale to start the year

A flatter yield curve, contentious politics, a $400 billion corporate sale, a tax gift for REITs and more bad news for retail. And that’s only the first week of the year. Contributions from CoreLogic, CS, GS, JPM and Milepost).

Markets: On towards flatter yields
Flatter. And maybe a little higher. That should be the direction for US rates. Tax reform should give a small lift to growth this year and, possibly, inflation. The bump in deficit spending from tax cuts should also help lift 5-year and shorter yields. The December FOMC minutes signaled a Fed on track to tighten between two and four times this year. The spread between 2- and 10-year yields since December 20 has dropped by 14 bp. Look for it to go to zero this year and for 10-year rates to range between 2.25% and 2.75%. See JPMorgan, US Fixed Income Markets Weekly, 5 Jan 2018. (JPM, Milepost).

Markets/economy: Upcoming in politics
On the political agenda for the foreseeable future: First, federal spending authority, which expires January 19 and has become tangled up in the debate over deferred action for childhood arrivals (DACA) and an $18 billion administration request for a border wall. Second, the US debt limit, which will need to be raised by March. Third, US deficits, which should rise with tax cuts and likely new fiscal spending and approach 3.7% of GDP this year and 5.5% by 2021. Fourth, infrastructure. Fifth, technical corrections to tax reform. And beyond these items come tweaks to Obamacare, financial regulations, GSE reform, international trade, and the looming 2018 midterm elections. See Goldman Sachs, US Economics Analyst: The 2018 Political Outlook: More Stimulus and New Trade Risks Ahead of the Midterms, 6 Jan 2018. (GS, Milepost).

Markets: A $400 billion sale to start the year
The first week of the year brought more than $400 billion in selling of longer corporate debt likely by Taiwan insurers, according to JPMorgan. Taiwanese investors had a 1-time opportunity to reclassify investments from old to a new accounting categories starting Jan 1, 2018, and apparently decided to take some gains before reinvesting. The new categories give Taiwan investors a little more flexibility to trade their accounts, but the selling doesn’t necessarily signal a material change in investment strategy. Taiwan insurers invest heavily in US corporate debt, callable agency debt and agency MBS. See JPMorgan, US Fixed Income Markets Weekly, 5 Jan 2018. (JPM, Milepost).

Markets: A tax gift for MBS REITs
December’s tax reform includes a gift for REIT investors, including those that invest in MBS. Investors will be able to deduct 20% of qualified REIT dividends. An investor with a 37% marginal tax rate, for example, consequently pays only 29.6%. For a REIT paying a 10% dividend, that’s a 74 bp gain in after-tax income. The REIT provision hasn’t had a clear effect on REIT stocks so far, but a lift to the sector could help REITs raise equity as they did in 2017 and become better buyers of MBS. The new benefit now makes REITs much more efficient than mutual funds as a way to hold MBS risk. See JPMorgan, US Fixed Income Markets Weekly: Agency MBS, 5 Jan 2018. (JPM, Milepost).

Markets: Retail rolls over CMBS again
Sears and Macy’s announcement that week that they would close more stores has put a range of CMBS deals at risk. Sears announced it would close 39 Sears stores and 64 K-Mart stores sometime between early March and April. Macy’s announced 11 closings. The Sears closings affect nine loans backing CMBS deals, including one loan that makes up 41% of the loan pool behind a 2006 CMBS deal. The Macy’s closings affect three CMBS deals. This is the latest round of bad news to hit CMBS as e-commerce continues to hurt bricks-and-mortar retail shopping, with loans to mall operators most at risk. Credit Suisse expects retail closings and bankruptcies to continue, weighing on rents and vacancy rates. See Credit Suisse, CMBS Retail Outlook: transformation accelerating, 4 Jan 2018, and Credit Suisse, CMBS Loans in the News: Another 64 Kmart and 39 Sears are closing, 4 Jan 2018. See also JPMorgan, US Fixed Income Markets Weekly: CMBS, 5 Jan 2018. (CS, JPM, Milepost).

Markets: Single-family rents slow
Rents on single-family houses rose 2.7% year-over-year through October, according to CoreLogic, down from a peak pace of 4.4% in February 2016. The most pronounced slowing came in the most expensive rentals. Trends in rents also varied widely across different markets. Las Vegas saw single-family rents rise 4.6% year-over-year through October, while rents in Miami dropped 1.3%. The CoreLogic post is here. (CoreLogic, Milepost).