Securitized Credit Market Update

These are some tricky talking points, with fresh geo-political risk in the air and an array of macro-data with differing implications when taken in isolation. 

• The payroll report was super hot while CPI and PPI data were surprisingly cool. 
• Powell seemed to take it in stride, although the Fed members’ torturous dot plot was split 8/7/4 of 2 cuts, one cut and no cuts this year, respectively. 
• While still early, elections in France have whispers of the Gilt crisis from 2022 embedded. 
• Market reactions have been easier to reconcile to each of them in isolation, but the conclusion on which way valuations will trend going forward is debatable and varies by market.

Thankfully, and as we will get to, securitized market dynamics have exhibited relatively low vol throughout and maintained positive excess returns.

Since our last set of notes, as alluded to, there has been considerable chop within markets. However, when measured on a month over month basis (May 15th to June 17 th), volatility has remained reasonably low (VIX +2.4% to 12.75; MOVE +5% to 92.6) and valuations in markets are mostly higher (SPX +3.2%, UST 10yr -6bps). Spread markets have ended up a bit wider (HY +15bps to 316, Agg +2 to 39bps) amidst the chop, with the last couple of days driving the widening.

Going into a bit more detail on the key events as we saw them from our securitized prism:

• This month, the labor market report was back to being received first by markets (recall last month’s 5/1 Fed meeting setting the tone). With recent reports and other labor market indicators (JOLTS Job Openings -296K MoM) suggesting moderation was in hand, the +272K (+180K expected) was jarring. The unemployment rate did tick higher to 4.1%, but so did wages (AHE +0.4% MoM, +4.1% YoY) leaving the report decidedly hawkish for market participants. The UST 10yr sold off 14bps on the day, one of the largest such moves of the year. 
• CPI & PPI, in contrast, offered decidedly dovish contrasts for market participants.
  • For CPI, the flat MoM headline represented an unexpected but welcomed downshift after 4 months of +0.3-0.4% increases.  
  • Core CPI also contributed to the positive reception in markets, with its +0.2% MoM print the smallest gain since October 2023, and the +3.3% YoY result the smallest increase since April of 2021. 
  • Shelter costs (close to our markets) was stoic, printing its ‘standard’ +0.4% MoM increase offering little reprieve but at least not showing upward pressure. 
  • Used car prices [surprisingly?] bumped higher +0.6% after a couple months of declines, but measure down -9.3% YoY. 
  • PPI was actually deflationary, printing down -0.2% MoM (+2.2% YoY), the biggest such decline in 7 months. While much of the move was on the back of lower fuel costs, downward pressure on goods and flat service costs all bode well for lower inflation.
•  The Fed meeting (6/12), in our assessment, wasn’t a catalyst to the same degree as the afore mentioned economic data. The updated dot plot, with its new median ‘1 cut’ is more hawkish than markets (~2 cuts) are currently priced, but with 8 members suggesting 2 cuts, it is clearly (and rightfully?) a close call – truly data dependent as we proceed through the year. 
• On the follow, updated real time GDP trackers remain solidly positive (Atlanta real GDPNow tracker +3.77% through 6/17) after dipping briefly late in May. 
• Far from home, elections in Europe last weekend have unsettled things a bit in markets (spread widening highlighted earlier has been in the last week). In particular, French elections and the subsequent surprise call for ‘snap elections’ in their parliament have driven some uncertainty getting priced. 
  • As alluded to above, concerns around the potential for budget deficits offer reminders of the volatility experienced in UK Gilt markets in 2022. Readers may recall volatility in US securitized markets manifesting as CLOs widened into elevated selling pressure from deleveraging pension plans. To be clear, we have noted no such flows in this current episode of European politics.

In response to this mixed bag of influences, risk markets have remained in generally good shape, with equity markets posting fresh highs yesterday (6/17), rates well off their peak and credit markets wider (see corporate credit), but fully functioning and liquid.

• Agency RMBS markets, which were the biggest underperformer YTD thru 4/15 (-66bps excess returns, -3.75 total return), have continued the run we highlighted last month, moving tighter with lower rates, returning 24bps of excess returns and 170bps of total returns MTD, leading fixed income sectors MTD. 
• Excess returns in fixed income credit sectors have been more of a mixed bag, with corporate credit (IG, HY) underperforming securitized (CMBS, ABS). 
  • MTD excess returns: HY -11bps, IG Corps -49bps, ABS -2bps, Non-Agency CMBS +2bps. 
  • CLOs have again remained well bid, despite the emerging uncertainty highlighted in France, as well as the prospect of rate cuts remaining priced in markets. The CLOIE has returned 32bps MTD, continuing to lead fixed income YTD with 425bps of total returns (Agg -27bps YTD).

Within securitized markets, these macro drivers have more or less been the key drivers with European politics driving limited spread widening. Liquidity remains deep and primary markets are fully open with robust investor interest.

Markets continue to feel tilted towards being a sellers’ market, with demand apparent across investor types for risk in virtually all securitized sectors, CMBS included, where CRE oriented headlines continue to roll through.

Pockets of the securitized markets have seen spreads nudge wider (parts of CMBS), but only minimally (especially when judged versus the YTD move) while most sectors reflect the ongoing strength in demand from ‘real money’ investors:

Our updated issuance table continues to reflect substantial YoY growth in issuance, evidencing an ongoing virtuous cycle (strong investor interest fueling more issuance, with improved credit performance fostering more risk taking and credit creation), on display in each sector:

As we offer some concluding thought4s regarding our outlook, seasonals are expected to play a role, albeit a changing one. 

As we enter the ‘summer doldrums’, the reinforcing dynamic of fresh allocations and risk appetite typically associated with a new calendar year has faded and is more vulnerable to ‘sloppiness’.

• As vacation schedules come into play with the conclusion of the school year, less populated trading desks and a potentially less anxious investor community can conspire to reduce liquidity. 

• This can particularly evident if/as risk-off market conditions emerge, i.e. with French election anxiety, even if direct fundamental feedback loops aren’t clear. 

• This can also work on risk-on days, where reduced available supply could drive more outsized moves tighter from protective trading desks and/or anxious investors with a touch of ‘FOMO’. 

• With that in mind, we’d expect doses of volatility to become more apparent and potentially more frequent into July-August. 

  • Vulnerable securitized sectors will vary and correlate to market technicals in play at the time, but have traditionally been tied to higher beta sub-sectors CRT and CLO. 

    • CLOs, which have enjoyed the higher for longer inverted curve dynamics (drives attractive income), may be particularly vulnerable as we progress in the Fed’s monetary policy regime. Coupled with extremely high issuance and spreads that have rallied considerably, we are cautious on this sector’s ability to continue to lead into the doldrums. 

• Across ABS, CMBS and non-agency RMBS, we like these sectors prospects to contribute to a fixed income’s outperformance potential. 

  • While we do not see a catalyst for meaningful spread tightening until we get actual Fed rate cuts, we look for them to enjoy steady sponsorship and deep liquidity as strong fundamentals fuel risk appetite across a wide range of macro scenarios. 

Best of luck and enjoy your summer! 

Voya Securitized Team