As we approach the midpoint of 2019, one of the most surprising market developments has been the resurgence of the bond bull market. Yields on US 10 Year securities which is viewed as the benchmark rate for GNMA project loan securities, are currently hovering at 2.14%. For perspective, those levels were last seen September of 2017 and since that point there have been FIVE fed funds rate hikes by the FOMC. Furthermore, over the last six months, we’ve experienced over a 100 basis-point drop in 10 Year yields. To say this would be a surprise to market participants at the beginning of the year would be an understatement. In a Bloomberg survey taken 11/9/2018, the average 2019-year end forecast for the 10 Year Treasury was 3.45%, with most of the market believing there would be two hikes in 2019. As with most market predictions, this may serve as good reminder to take it with a grain of salt.
A few factors are behind this resurgent bond market. Geopolitical tensions continue to produce headlines daily. The inability of the U.S and China to reach common ground over the yearlong “Trade War” has lead to lower expectations for global economic growth. According to a study prepared by Trade Partnership Worldwide, if all tariffs proposed by the U.S were implemented, combined with Chinese retaliation, it is estimated to curb U.S GDP by (~1%) annually. Meanwhile, this period of uncertainty has led to a flight to quality in safe-haven assets, which has acted as a catalyst for the bond market rally (yields fall as bond prices rise). Other risks abroad include, a dimming outlook for Euro area growth, potential fallout from Brexit proceedings, and mounting tensions between the U.S and Iran in the Middle East. Another more recent development that could cause some concern would be the commingling of political issues with economic policy as seen with the U.S threatening to place tariffs on Mexico if they are unable to take more action on U.S immigration.
With regards to monetary policy, the Fed continues to preach patience going forward. Despite not hitting its 2% inflation target, the U.S economy seems to be on solid ground as we near the later stage of its expansion cycle. However, policy makers are now in the market’s crosshairs, as virtually the entire yield curve is below the fed funds rate and the likelihood of an interest cut in July 2019 is 78% while December 2019 is above 90%. While inflationary data may not support a cut, going forward it will be interesting to see if the FOMC deviates away from its data driven decision making and bows to market forces.
After a tumultuous start to the year due to the government shutdown, GNMA project loan securities have come back to life, as investors have tightened spreads ~15 basis points since January. Strong demand looks likely to stay as prepayment speed assumptions tick up. Broker dealers; who provide capital to this space, largely have clear balance sheets and appetite to do deals, feeding the natural supply and demand fundamentals needed to keep spreads in check. We continue to see strong demand for Agency products regardless of spikes in market volatility and lower yields. Spreads on shorter term DUS paper have held firm year to date, while we’ve seen some tightening farther out the curve as more investors are trying to get their hands on yield.
Merchants Capital Corp. (MCC) has originated and closed more than $13 billion in loans since its inception in 1990 and now services more than $10 billion. Merchants Capital Markets group serves as a conduit between MCC customers and the real estate capital markets by marketing GNMA and FNMA securities directly to Wall Street in order to obtain the best execution.