TRV Mid-Month Commentary | May 2015
Policy Update:
Before we provide an update on
our markets, we would like to outline an important FHFA proposal that, if
passed, will have significant impact on the markets in which we trade. On May
15, the FHFA released an update on the structure of the Single Security in
accordance with the goals set out in the 2014 Strategic Plan for the
Conservatorships of Fannie Mae and Freddie Mac. The main goals of the Single
Security are to build a Common Securitization Platform that adds market
liquidity and reduces or eliminates taxpayer costs of Freddie Mac
securitizations.
Freddie Mac securities
traditionally trade at a discount to comparable Fannie Mae due to reduced
liquidity. If the proposal is passed, we expect Fannie Mae and Freddie Mac
securities to trade close to parity during and after the transition. Overall,
we believe the proposal will increase market liquidity and reduce taxpayer
costs as mentioned by the FHFA.
Comment:
Despite the disappointing revision to March’s Change in Nonfarm
Payrolls, Treasuries sold off dramatically in the first half of the month. 10yr
yields ended 26 bps higher and the curve steepened 12 bps 5s/10s. We expect IOs
to perform well in a higher and steeper yield curve environment. Likewise, we
would expect CMBS and residential credit to generally increase in valuation as
buyers seek yield.
One impact on valuations would be an increase in delivered and implied
volatility. Over the past two weeks, swaption volatility increased 13 bps (1
month into 10 year). Since our portfolio is tactical in nature, we stand to
benefit from dramatic market changes that lead to mispriced assets. Pass-throughs
may present such an opportunity as prices dramatically lagged those of
Treasuries. We thus see an opportunity to be long the mortgage basis given
recent underperformance and the likelihood that Treasury yields will remain
range bound until further direction from the Fed. Decreased prepayment risk
should provide further tailwind to the pass-through market and provide
opportunity for spread compression.
In April, 30yr and 15yr conventional mortgage speeds declined beyond the
street’s expectations. The key surprise for many investors was a larger than
expected slowdown in new vintage collateral. This may signify that the street
prepayment models are mis-calibrated to refi-sensitivity and, in our view, the
market is under-valuing many prepay-sensitive bonds. As such, we have seen IO
valuations rally and we continue to also look at other asset classes for
opportunity.
Spread products, such as CMBS and residential
credit, may be such asset classes with foreseeable spread compression as higher
rates often indicate an improving economy. Commercial property fundamentals
remain strong and we expect the trend to continue. In residential credit, we
see limited upside to legacy positions, except in specific niche sectors. But
at the same time we do not anticipate major spread widening in the near term as
housing fundamentals and market technicals remain strong and supportive of the
sector. Of note, we see value in Credit Risk Transfer (CRT) deals and point to
wider spreads vs legacy RMBS particularly during market pull-backs.
While valuations on securities that stand to
benefit from slower prepayments continue to grind higher, we are positioning
ourselves to be opportunistic. We expect rates to end May higher as the market anticipates
the pending Fed activity. However, we foresee near-term volatility remaining
elevated given the uncertain nature of the forward rate path. As we mentioned, our
strategy should benefit from such volatility as it will create openings for our
tactical approach.
Regards,
Tradex Global Advisory Services, LLC
investorrelations@thetradexgroup.com
203-863-1500
@Tradex_Global
