By Serafino Tobia, Managing Director & Head of Agency CMBS Trading, Greystone
US Treasuries
10-year Treasuries are at 4.57% as of mid-day October 11. 10-year Treasuries ended last week at 4.80% -- - that’s after two weeks of interest rates gapping higher, driven by strong economic and employment data early in October. The improvement in rates over the past few days reflects a move to safer investments after the terrorist attack in Israel this weekend. We would expect the markets to continue to reflect risk aversion based on the news about the conflict in Israel and the possibility of a broader conflict.
Before the conflict in Israel, the bond market was focused on the employment data. On October 3, the August JOLT report showed job openings of 9.6 million, a reversal to the declines in June and July. For context, the high mark was 12.03 million job openings in March 2022 and, prior to the pandemic, the high mark was 7.6 million. In other words, the demand for workers remains strong. We also got an oversized September job report on October 6 as non-farm payroll added 336,000 jobs; the consensus estimate was for 170,000 new jobs (last month, August, was 187,000). In short, the notion of an impending recession (that would give room for the Fed to start normalizing monetary policy) has been pushed further into 2024.
We’ve likely seen the high-water mark on 10-year rates, but that’s not possible to say with conviction as evidenced by the recent volatility. Markets are clearly trading off concern over the possibility of a broader conflict in the Middle East, hence Treasuries get a stronger bid with a flight to safety. Additionally, Fed officials have been indicating that the Fed is ready to pause any further increases in the Fed Funds rate. Fed Funds rate is currently at a 5.25% - 5.50% target range (from near-zero in early 2022).
On October 5, Mary Daly, the President of the Federal Reserve Bank of San Francisco, commented that, with the recent substantial increases in interest rates in the market, the bond market itself had tightened credit availability and therefore the Fed could hold off on any further Fed Funds rate increases. We have heard similar comments from other Fed officials as well over the past couple of days.
In theory, Fed Chairman Powell is in the process of writing his legacy. For the right reasons or not, The Fed’s (Powell’s) easy money policy during the pandemic (near-zero interest rates, massive asset purchases, QE), contributed substantially to inflation over the past two years; inflation peaked at 9.1% in the summer 2022. Powell is now fully intent on reversing the inflation effects of his zero-rate/easy money policy, and the resilience in the economy (sub-4% employment, 2%+ GDP) gives Powell cover to stay hawkish, possibly raise the Fed Funds rate one more time and keep financial conditions restrictive. Before the November 1 FOMC meeting, we will get CPI and PCE Index inflation reads, GDP and other economic reports. Likely, Powell will err on being too restrictive rather than call a victory on inflation too soon.
Another ¼ point Fed Funds rate increase at the next FOMC meeting or not, it’s clear that the Fed’s intent is to stay restrictive to push inflation back to its 2% target. As we’ve previously discussed, even with expected inflation at 2%-2.5%, the 10-year Treasury rate should be somewhere around 4% - 4.50% (after including spread for a real yield and a term premium in line with historical averages). While a hawkish Fed helps keep a lid on rates moving even higher, over the near term, a higher Fed Funds rate (and the Fed keeping it higher for longer) will keep pressure on 10-year rates to compensate investors to go out longer on the curve.
Interest rates will continue to move with news regarding the conflict in Israel and the possibility that the conflict could become more widespread. Additionally, interest rates will key off the economic data; the data drives the Fed’s monetary policy as well as inflation expectations. Inflation has been slowing for over a year now and continues to move lower, but at a slower pace. This week’s print of the consumer prices (CPI) tomorrow October 12th could be significant. Top-line CPI (year-over-year) is expected to be +3.6% (vs. +3.7% last month’s print). The highly-watched CPI Core (ex-food and energy), is expected to be +0.3% month over month (the same as last month’s print).
FNMA and GN/FHA spreads
Agency CMBS and GNMAs spreads are about 8 basis points higher over the past 10 days. Fannie Mae DUS® new loan rate lock volume among all lenders was only $260 million this past week (far below the $750 million weekly average year-to-date). Wider spreads reflect the volatility in the Treasury market and the spread widening with competing spread product, residential MBS, CMBS and corporate bonds.
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