Treasuries Remain Near Range Highs
With little in the way of material economic releases to disturb the market, price action in Treasuries will be the story in itself. All eyes have been on the 10-Year note as it jumped out of the gate on Tuesday following the long weekend and posted a weekly high of 1.33%, and nearly the highest yield in the last year which included the last couple halcyon weeks of pre-pandemic living. That 1.33% level was tested twice on Wednesday but each time buyers arrived to pull yields lower. After the quick test of 1.33% on Tuesday night/Wednesday morning, yields have settled into a 1.26% -1.31% range. Does that mean the selling impulse has faded? Well, it’s too early for that call but there was little reaction to very strong retail sales, PPI, and Industrial Production on Wednesday indicating the market seems generally comfortable where it is for now. Later this morning, we get January existing home sales and activity is supposed to be off December’s heady totals but a very solid showing is expected once again.
We mentioned on Wednesday the steepening that has been going on in the Treasury curve. With the short-end in a lockdown of sorts given the Fed’s forward guidance on keeping fed funds near zero for the foreseeable future, longer maturity yields have been in a slow grind higher since August. That has led to the 2yr-10yr Treasury yield spread widening to a four-year high, most recently in a 117-120bps range. With spreads at multi-year highs and liquidity on bank balance sheets at some of the highest in years, deploying a good chunk of that liquidity seems prudent given the Fed’s almost strident calls to be on the sidelines for the foreseeable future.
The above table, from S&P Global Market Intelligence, shows the most recent changes to balance sheet make-up as of February 8th. Notice the almost unchanged loan balances away from PPP loans YOY. Notice also the significant increase in investment securities for the last year, but also notice interest-bearing cash balances have soared YOY as well. Thus, nearly $3 trillion of bank liquidity remains mired in low-yielding deposits. Plus, the coming Stimulus 3.0 will only add to that cash horde, and those rates are likely to remain low for a couple years. That’s no way to boost net interest margins. Moving more of those low-yielding interest-bearing balances into other investments seems wise, especially with multi-year steepness back in the Treasury curve.
Net Interest Margins Stabilizing But Banks Still Underinvesting Their Liquidity
We hammer on about deploying excess liquidity because of the chart below. Net interest margins have been in decline since the third quarter 2019 with a precipitous drop when the pandemic hit. As the previous table showed, loan growth has been almost non-existent outside the 1% PPP loans. While investment portfolios have taken on the lion share of growth in the last year, there remains a sizeable amount of cash sitting in low-yielding deposits and they are likely to remain low yielding for the next two years, or more. While margins have started to stabilize over the last two quarters, the back up in longer-term rates, coupled with the still sizeable liquidity sitting on bank balance sheets, means deploying more of this liquidity should be considered now. Also, you may be wondering how ‘sticky’ is all that liquidity? Our experience is that the deposits are stickier than most first thought, and we would note more liquidity is coming once Stimulus 3.0 is signed into law which should happen in the next few weeks.
Option Volatility Spiking Means More Yield for You
How about another reason to consider investing now rather than wait for higher rates later? The graph shows the MOVE Volatility Index which is a weighted measure of Treasury price volatility. With the move in long rates recently the spike in volatility is obvious. It’s the highest since pre-election and the uncertainty around that event. What the increase in volatility means for you is that securities with options, like callable agencies, step-ups, and MBS will provide you with greater yield all else being equal. When you buy a callable security you are essentially selling a call option and when volatility increases that option increases in value. That increased value reveals itself in a higher yield to you versus in a lower volatility environment.
|Treasury Curve||Today||Chg Last Wk.||LIBOR Rates||Today||Chg Last Wk.||FF/Prime||Rate||Swap Rates||Rate|
|3 Month||0.03%||Unch||1 Mo LIBOR||0.11%||Unch||FF Target Rate||0.00%-0.25%||3 Year||0.311%|
|6 Month||0.04%||Unch||3 Mo LIBOR||0.18%||-0.01%||Prime Rate||3.25%||5 Year||0.693%|
|2 Year||0.11%||Unch||6 Mo LIBOR||0.20%||-0.01%||IOER||0.10%||10 Year||1.391%|
|10 Year||1.31%||+0.10%||12 Mo LIBOR||0.30%||Unch||SOFR||0.06%|
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