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Fixed Income Recap – December 2016

December 22, 2016

Market Recap: 10 year U.S. Treasury yields increased 26bps in October, largely a reflection of lower global stimulus expectations. GDP rose in the 3rd quarter (2.9% versus an expected 2.6%), which is the highest read in two years. Many economists forecast that the U.S. economy will continue to grow at a 2.0 to 2.5% level. Oil prices dropped from $52 to $47 per barrel during the final two weeks of October.

The rates markets will likely endure heavy volatility going into year end with the impending Presidential election, as well as two more FOMC meetings. There is little expectation for the Fed to hike rates in November (16.10% probability), only one week prior to the Presidential election. However, it is likely that they do so on December 14th (72.6% probability).

Mortgages: Spreads remained tight especially in short duration paper where bids are strong. Depending on the coupon and cash flow, spreads are 2-5 bps tighter MoM, providing sellers with opportunities to lock in profits. The October pullback has made the +2.00% yield bogey attainable in cleaner cash flows. Depositories looking for stable cash flow turned to 5yr PACs that offer both call and extension protection. The call/extension theme is gaining momentum, especially amongst depositories, as uncertainty in the rate markets mounts.

CMBS: FNMA DUS continues to be a target for buyers that covet positive convexity and structured cash flow. 5yr FNMA DUS provides a +30-35 bps pick in yield above comparable 5yr Agency bullets with similar extension/call protection that bullets provide. Going forward, most Fannie Mae new issuance will settle in 2017 due to cap limitations.

Municipals: Municipal funds experienced outflows for the first time in over a year. This selloff coincided with the downward pressure in Treasuries throughout the past couple of weeks. Issuance throughout the month of October has put municipals on track to surpass 2010, the largest issuance year for the sector. Only $40 billion is needed to exceed that historic supply. MoM, the long end of the curve lagged as spreads gapped out. Moreover, the backup pushed the Municipal to Treasury ratio above 100%, which created a “cheap” opportunity in longer maturities. Ratios and spreads are even greater in Non-BQ/General Mkt municipals.

Corporates: Credit spreads closed the month 4 bps tighter. Most recent activity and the best opportunities have been in 5 to 8 year duration, A-rated bonds. The recent trend could continue if the 10 year approaches 2% and spreads tighten. The last couple of weeks provided a nice opportunity for clients to take profits and extend out the curve to take advantage of the roll at the beginning of 2017.

10 year U.S. Treasury yields increased 26bps in October, largely a reflection of lower global stimulus expectations. GDP rose in the 3rd quarter (2.9% versus an expected 2.6%), which is the highest read in two years. Many economists forecast that the U.S. economy will continue to grow at a 2.0 to 2.5% level. Oil prices dropped from $52 to $47 per barrel during the final two weeks of October.

The rates markets will likely endure heavy volatility going into year end with the impending Presidential election, as well as two more FOMC meetings. There is little expectation for the Fed to hike rates in November (16.10% probability), only one week prior to the Presidential election. However, it is likely that they do so on December 14th (72.6% probability).

Mortgages: Spreads remained tight especially in short duration paper where bids are strong. Depending on the coupon and cash flow, spreads are 2-5 bps tighter MoM, providing sellers with opportunities to lock in profits. The October pullback has made the +2.00% yield bogey attainable in cleaner cash flows. Depositories looking for stable cash flow turned to 5yr PACs that offer both call and extension protection. The call/extension theme is gaining momentum, especially amongst depositories, as uncertainty in the rate markets mounts.

CMBS: FNMA DUS continues to be a target for buyers that covet positive convexity and structured cash flow. 5yr FNMA DUS provides a +30-35 bps pick in yield above comparable 5yr Agency bullets with similar extension/call protection that bullets provide. Going forward, most Fannie Mae new issuance will settle in 2017 due to cap limitations.

Municipals: Municipal funds experienced outflows for the first time in over a year. This selloff coincided with the downward pressure in Treasuries throughout the past couple of weeks. Issuance throughout the month of October has put municipals on track to surpass 2010, the largest issuance year for the sector. Only $40 billion is needed to exceed that historic supply. MoM, the long end of the curve lagged as spreads gapped out. Moreover, the backup pushed the Municipal to Treasury ratio above 100%, which created a “cheap” opportunity in longer maturities. Ratios and spreads are even greater in Non-BQ/General Mkt municipals.

Corporates: Credit spreads closed the month 4 bps tighter. Most recent activity and the best opportunities have been in 5 to 8 year duration, A-rated bonds. The recent trend could continue if the 10 year approaches 2% and spreads tighten. The last couple of weeks provided a nice opportunity for clients to take profits and extend out the curve to take advantage of the roll at the beginning of 2017.
October16Tables

Data as of 10/31/16

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