Fed Cuts Rates But Treasuries Remain Unimpressed
The Fed’s first inter-meeting rate cut since 2008 didn’t stem the fear and angst in stocks, and it added rocket fuel to the rally in Treasuries. The size of the cut (50bps to 1.00%-1.25%) was generally expected but the timing was uncertain with many, including us, thinking they would wait until the March 18 FOMC meeting. After the emergency G7 meeting earlier in the day where finance ministers agreed to work in concert to alleviate virus-induced stress, along with Australia’s 25bps rate cut, the Fed’s move became less surprising, but it also opened the door to the “what do they know that we don’t” line of reasoning, and that accounts for much of the subsequent risk-off move in stocks. This morning, global equities are bouncing but we’ll see if it sticks. Italy just announced it’s shutting all schools and universities so the viral spread continues. That fact could be why fed funds futures are pricing in another 40bps cut for the March 18 FOMC meeting. Futures also see the funds rate at 0.43% at year-end. Welcome back to the land of the zero-lower-bound.
With the Fed cutting the funds rate 50bps yesterday, one has to consider what else the Fed is watching. While domestic economic numbers have been solid, the sense is that it is the calm before the storm. Certainly, when one sees the impact to China, the second largest economy in the world and manufacturer to the globe, it’s easy to see why they cut rates between meetings for the first time in a dozen years. Take a look at the most recent PMI readings from China released last weekend.
Those cliff-edge declines are not surprising given the extensive quarantines in Wuhan and self-isolation programs instituted across the country. Similar declines were noted in car sales (down 80%) and Macau gaming revenue (down 90%). What those numbers mean for the country’s GDP are shocking as well (see yellow line in graph below). The second largest economy in the world doesn’t go flat on its back and the rest of the world emerge unscathed. The Fed no doubt had these charts in hand when considering when to act, and the better part of valor was to act sooner rather than later.
Lower Mortgage Rates and Higher Refi’s Signal Another Prepay Wave
With the move to all-time low long-end Treasury yields mortgage rates will surely follow suit. That opens a wider universe of the existing stock of mortgage loans to refinancing activity, and that will subsequently lead to increased prepayments on mortgage pools and CMO tranches. The latest refi index spiked to a 7-year high and that was prior to 1.00% 10yr yields.
Obviously it will take time for the latest move lower in rates to work through the mortgage market and for refi applications to become closed loans but the time may be now to scour your mortgage portfolio for pools that may be susceptible to potential increases in prepayments. Higher coupon pools, higher balance loans, pools with a higher percentage of third-party originators (think Quicken Mortgage and their ilk), and loans originated in 2018 and early 2019 could all be in for increasing prepayments as the latest Treasury rally works its way through the mortgage market.
Also, we have a Bloomberg template that will look back one year to determine how an MBS pool is yielding at 1-month, 3-month, 6-month and 1-year prepayment speeds. This analysis will identify those bonds already starting to experience faster prepayments. If your portfolio has material investments in MBS pools, and which portfolio doesn’t, it may pay to have your CenterState representative run an analysis and determine if a swap could stabilize yields in the face of increasing prepayments.
Agency Indications — FNMA / FHLMC Callable Rates
|Maturity (yrs)||2 Year||3 Year||4 Year||5 Year||10 Year||15 Year|