TRV Mid-Month Commentary | August 2015
Comment:
The news cycle for the first half of August has been dominated by global
growth concerns following the People’s Bank of China’s surprise decision to
devalue the Yuan that resulted in the largest one day decline in two decades. Global
markets largely saw the move as a play to increase export activity, spurring
fears of a decline in global growth that set the tone for a risk-off mentality.
Global economic concerns have also caused investors to contemplate
whether the Fed will move in September, and July’s change in Non-Farm Payrolls
provided little guidance to potential Fed policy as the numbers came in at
expectations. We note that the market has turned more bearish on a September
hike as the Fed Funds futures market implies a 36% probability of such an
occurrence,
down from near 50% a few weeks ago. Although the Fed’s most recent Dot Plot
implies two hikes in 2015, we are less certain of this outcome following recent
news. Despite the uncertainty
surrounding a September hike, 10yr yields managed to increase 2 bps to 2.18
while 5yr yields increased 7bps resulting in a 5bp 10/5 bear flattener.
In this backdrop, securitized
credit faced headwinds as spreads were pushed wider and weaker credits
underperformed due to a steepening of the credit curve. While weakened
sentiment regarding the global economy has had an impact on the credit
instruments, the US housing and economic fundamentals remain supportive.
We view these dips as buying opportunities with the expectation that
fundamentals will ultimately drive spreads tighter. At current levels,
there is value in last cash flow tranches of GSE credit risk transfer bonds as
well as in BBB-rated single family rental securitizations.
Non-traditional ABS such as aircraft, NPLs, and marketplace lending
transactions offer incremental yield and have weathered the recent volatility
quite well due to strong investor demand.
Recent market action and the risk-off sentiment has likewise affected hedged
return on the mortgage basis: hedged with 5yr Treasuries, premium 4.0s widened
2 ticks, while widening 8 and 5 ticks versus the 10yr and Treasury Curve
hedges, respectively. Premium 4.5s, however, performed poorly against bullet
and curve hedges having widened between 7 and 10 ticks. Since August 1st,
the basis has cheapened between 5 and 9 ticks owing to deteriorating rolls, low
level of rates and diminishing bank, oversea and REIT demand. We consider the
timing may perhaps be ripe for a tactical long position, but our long-term view
leans much more bearish. We tread cautiously at this juncture and look to
September for clarity.
Since the end of June, we note that the mortgage rate has fallen 27 bps and
that the refi index continues to climb from its June low. That said, we expect
a 5-10% decline in prepayments from
July to August on lower turnover and refi activity, particularly for cuspy 3.5s
and 4.0s of 2013 & 2014. While this sounds counterintuitive, it is
important to mention that the Refi Index is a leading indicator and refi
applications take some time to work its way through the pipeline. Over the last
couple of months, option-adjusted spreads on IOs and Inverse IOs have remained relatively
stable. However, a surprise decision from the Fed could temporarily cause spreads
to dislocate and provide advantageous volatility.
As September looms, we continue to find pockets
of opportunity in our markets but remain cautious due to potential knee-jerk reactions.
Overall, we think the coming months will yield abundant opportunity.
Regards,
Tradex Global Advisory Services, LLC
investorrelations@thetradexgroup.com
203-863-1500
@Tradex_Global
