Every little thing, gonna be all right — Heading into the national elections, bond market volatility—as measured by the ICE Bank of America MOVE Index—reached highs not seen since a year ago when the Federal Reserve (Fed) pivoted, and economic data grew weaker for several months. Post-election, bond-market hysteria has subsided: From November 4 to 8, the MOVE index dropped by about 25% (Figure 1).
But borrowers aren’t necessarily feeling the same respite; U.S. Treasury yields have been under pressure for two months. For example, the 10-year note has been on the upswing since touching 3.60% in mid-September. The yield on the 10-year note reached a recent high of 4.50% on Friday, before closing at 4.43%, up 13 basis points (bps) for the week. Last week’s sell-off in Treasuries was driven by: (1) October Consumer Price Index (CPI) and Producer Price Index (PPI) prints, which showed that inflation has basically flatlined (or even increased slightly) over the past three months; (2) uncertainty surrounding the economic impact of the new administration’s policies; and (3) lower expectations for the Fed’s easing through next year.
October headline CPI met expectations, rising 0.2% month over month for the fourth consecutive month. The year over year headline rate increased to 2.6% in October, marking the first annual acceleration since March (September was 2.4%). The sticky shelter and owner’s equivalent rent sub-indices both rose from September. Meanwhile, October PPI came in higher than expected at 0.2% month over month and 2.4% year over year—compared to 0.1% and 1.9%, respectively, in September.
Until very recently, declining inflation had largely given the Federal Open Market Committee (FOMC) room to cut rates. A stagnation of that progress, however, could give Fed officials pause before cutting rates further. Below are some quotes from Fed officials last week.
- Fed President Neel Kashkari (non-FOMC voter) said: “If we saw inflation surprises to the upside
between now and then [the next FOMC meeting], that might give us pause [to cut rates].” - Fed Chair Jerome Powell said: “The economy is not sending any signals that we need to be in a hurry to lower rates.”
- Fed Governor Adriana Kugler (FOMC voter) said: “If any risks arise that stall progress or reaccelerate inflation, it would be appropriate to pause our policy rate cuts.”
- Fed President Susan Collins (non-FOMC voter) said that a December rate cut is “not a done deal.”
The odds that the Fed cuts again in December have accordingly diminished; ditto for the odds of cuts in 2025. On November 1, for example, there was an 85% probability the FOMC would cut 25 bps on December 18, according to federal funds rate futures. Yet that probability had shrunk to 58% by last Friday. Likewise, the total of cuts forecast for 2025 also dropped—from about 120 bps (as of November 1) to 75 bps (as of November 15).
The bond market, in turn, is constantly deciphering clues to determine where rates are headed. Both the Fed’s messaging and economic shifts underfoot seem somewhat conducive to a higher interest rate environment (positive growth, stable labor market, strong consumer sentiment, elevated inflation, etc.). Interest rates are still relatively low as well: A yield of 4.45% on the 10-year Treasury note is high for recent years, but not high in historical context (Figure 2).
A different take on MBS spreads — We analyzed both the coupon rates and spreads over 10-year Treasury yields for Ginnie Mae permanent loan (perm) mortgage-backed securities (MBS) and Fannie Mae DUS 10/9.5 MBS. Figure 3 shows that the current spread for Ginnie Mae perm MBS is broadly in line with the long-term average from 2013 to the present (i.e., centrally located in the 50 to 175 bps historical range). Current borrowing rates, however, are high compared to rates seen over most of the past decade.
For investors who are rolling the dice on lower rates, there is room for spread compression on Ginnies; we expect that such compression will occur in the near term. Experience and current market conditions suggest that the maximum compression would be 30 to 40 bps. The Ginnie outlook, on the other hand, is tenuous: The buyer base for MBS that end up in Ginnie Mae REMIC securitizations remains disjointed and soft after the collapse of Silicon Valley Bank in March 2023 and other regional banks thereafter. A steeper yield curve would likely provide momentum for Ginnie MBS spreads to contract.
We also analyzed coupon rates and spreads over 10-year Treasury yields—from 1999 to the present—for Fannie Mae DUS 10/9.5 MBS DUS. Figure 4 shows that the current spread (about 50 bps) is below the long-term average. Lower spreads than those seen today mostly came during the Covid-19 pandemic, when the Fed bought agency MBS to provide liquidity to our market.
Here, the odds of spread compression from greater investor appetite appear to be low. Instead, lower Treasury yields seem to be the more likely path to a significant drop in borrowing rates. The bottom line: spread compression for Fannies has more headwinds than for Ginnies.
At the same time, spreads may not have the last word in this story. That’s because Treasury rates are the biggest driver of borrowing costs for Fannies and Ginnies alike, so don’t be surprised if the terrain remains volatile regardless of where investor spreads land.
FROM THE DESK
Agency CMBS — It was an understandably light week, given the rate movement. Nevertheless, we heard of strong investor appetite with limited supply. Ginnie Mae spreads tightened by about 10 bps, while DUS was mostly unchanged. With the creep higher in rates, some Ginnie investors are requesting more restrictive prepayment strings, often with multiple 10s up front.
Municipals — AAA tax-exempt yields were slightly lower to flat throughout the yield curve, week over week. The market continued to see spreads widen to over 90 bps on cash-collateralized deals coming to market. Such deals priced at spreads of about 60 bps at the beginning of October. Municipal bond funds saw a 19th straight week of inflows last week, with $305 million arriving ($20.79 billion of inflows year to date). The high-yield fund subset continued to see inflows too, with $150 million arriving last week (29th straight week of inflows).
The information contained herein, including any expression of opinion, has been obtained from, or is based upon, resources believed to be reliable, but is not guaranteed as to accuracy or completeness. This is not intended to be an offer to buy or sell or a solicitation of an offer to buy or sell securities, if any referred to herein. Lument Securities, LLC may from time to time have a position in one or more of any securities mentioned herein. Lument Securities, LLC or one of its affiliates may from time to time perform investment banking or other business for any company mentioned.
