Stimulus Bill Optimism Returns
Treasuries have entered a listless trading period and that’s likely to continue until we get some resolution over: Stimulus 2.0, Senate majority, and clarity on vaccine take-up and virus case counts. Save for the stimulus bill possibly, none of these issues will be resolved this week, or this month frankly. So expect the listless trading to continue. Meanwhile, economic reports will come and go with little acknowledgement from the markets as they remain focused on the above drivers. The latest news is that the White House has offered up a $916 billion proposal and that has reenergized the risk-on stock trade this morning. We talk about the factors driving yields of late in more detail below.
Treasury yields find themselves in a listless zone with several uncertainties blunting the desire to move in either direction. The modest back-up in yields that we’ve seen for the last two months was largely predicated on a stimulus 2.0 bill and a likely Biden Administration that would be more willing to deploy large-scale fiscal help. Both of those assumptions remain uncertain.
First, the bi-partisan $908 billion stimulus proposal got a cold reception from Senate Majority Leader McConnell who still prefers his proposal which is much more austere. The key sticking points revolve around two issues: a liability shield for businesses and state and local government funding. McConnell wants a broad and expansive liability shield and no funding for state and local governments. The Democratic side of course wants the funding but are less excited about the liability shield. It seems a bill that emerges will have both those elements or none of them. The White House reentered the fray yesterday with a $916 billion bill so expect renewed enthusiasm from investors that something will happen and soon. While a stimulus bill remains unresolved it seems if one does pass it will be less than half the initial CARES Act and smaller than what investors were probably expecting just a short time ago. Thus, Treasury yields may have backed-up too much in anticipation given current stimulus realities.
Second, while a Biden Administration is a fait accompli the fate of the Senate hangs on the January 5 runoffs in Georgia. The importance of those races can’t be overstated with clear implications for Treasury yields. With a Republican win in just one of the two races will keep the Senate in Republican control and surely blunt the most ambitious of Biden’s fiscal plans. A Democratic win in both, combined with a vice presidential tiebreaking vote, gives the Dems a slight ruling majority. Polling is close and while investors have probably decided it’s a bridge too far for Dems to take both seats, the market, we think, underappreciates the degree of stonewalling that a McConnell-led Senate will deploy to frustrate any plans by the Biden Administration. Thus, this back-up in yields predicated on big fiscal measures could be too much given political realities.
Finally, the positive news on vaccines has surely worked to bias rates higher, but while FDA approval of the Pfizer vaccine is imminent, and Moderna’s set for next week, how quickly and how extensively will it be deployed across the population? Already, promises of 300 million doses by year-end have been reduced to 30 million. Also, the latest poll shows nearly 40% of Americans not willing to take the vaccine. With what will surely be a dark time in January and February, will vaccines live up to the herd immunity expectation by the third quarter of 2021? We remain skeptical of that and that is another reason we see the yield back-up in anticipation of that development in 2021 to be somewhat overdone.
November Prepayment Speeds Slow But Negative Yields Still Abound
We’ve been on about acting proactively to limit portfolio damage from MBS pools with excessive prepayments for some time now and once again we return to the subject. Even though November speeds slowed from prior months there are still plenty of pools/tranches that are expected to kick out negative yields over the next six months. The chart below is from our mortgage desk and are pools/tranches from our bond accounting clients with the bonds sorted by worst expected six month yields per Bloomberg’s BAM model (6mV Y column).
Several things jump out at us from this table. First, notice the worst yield performers come from the CMO category. That’s one of many reasons we tend to prefer pools over CMOs. Away from the CMO issue notice too that GNMA issues seem to also suffer more negative yields than Freddie and Fannie pools. Also, look at the Settle Date and you’ll see plenty of pools issued this year that are spitting out negative yields. While the settle date can include bonds issued earlier but sold in 2020 by looking at the Original Face versus Current Face one can quickly determine the newer bonds. The point is that thinking new issues will insulate you for a time from prepayments isn’t a guarantee as the table clearly shows.
We can run this type of analysis for your MBS portfolio and identify those bonds that might be at risk of kicking out negative yields over the next six months and work up a possible swap to ameliorate the problem. Please contact your CenterState Bank sales rep for more assistance and guidance in this area.
Agency Indications — FNMA / FHLMC Callable Rates
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