Securitized Credit Market Update

In this time warp of a market, thanksgiving feels like it was a blip on the radar from months ago. Conversely, the next set of holidays is pressing on me urgently. I hope everyone enjoyed themselves and are set for some relaxing days in these final weeks of the year. 

It feels like just yesterday as I was penning the January 2024 talking points. The year was ‘fresh anew’ and spirits were reasonably high, coming off a semi-glorious Q4 rally on the back of the Fed’s ‘pivot party’, which saw the 10yr rally 105bps and equities rally 14% (SPX) in Nov-Dec. 

The overall set-up for the 2024 calendar year was reasonably favorable, which markets projecting 5+ rate cuts into an economy with a tight labor market and foundation for continued economic growth. 

• As usual, we had plenty to worry about, with geopolitics and domestic uncertainties set to unfold over the course of the year. However, there seemed to be room for the economy and markets to deliver with consensus growth expectations below trend.

And while all of those rate cuts did not materialize (looks like we will end up with 3 as of press time), economic growth has proven resilient, and markets have posted another very strong year. 

• Annualized Q3 GDP was 2.8% and real time trackers have Q4 GDP growing at 3.3% (source: Atl Fed’s GDPNow).
• YTD SPX is +27%, HY OAS has rallied -61bps, non-agency CMBS -74bps.

So, when I reflect on markets and the economy for the year overall, I would have to assess it as surprising to the upside, both in terms of economic growth and market results. 

Bringing things back to our more current assessment, election results in the US have continued to the dominant force in markets. We have had some consequential pieces of data (November payrolls bounced back decently +227K, unemployment +0.1% to 4.2%; November CPI stubborn +0.3% MoM, 2.7% YoY), but policy related issues seem to be driving the beta from our securitized prism. 

Of course, with the inauguration still over a month away, actual policy has yet to directly impact the economy, but optimism is already high that it will do so. 

Since our last talking points in mid-November, equities, rates and credit spreads have rallied: 

• SPX +3.1%, 2yr -6bps, 10yr -4bps, HY OAS -4bps, IG corps -3bps, NA CMBS -9bps. 
• Volatility, perhaps predictably, has also moved lower during this time frame with the VIX receding 2+ pts and the MOVE -17pts(!). 

In short, the everything rally has continued, although the day to day has turned choppier in recent days as valuations seem to be plateauing for the time being, looking for a potential fresh new catalyst (December Fed meeting, new Trump tweets) for the next leg [higher]. 

To confirm, securitized markets have continued to trade higher with broader markets in the post-election period. This has been decidedly more ‘real time’ than has typically been the case when fresh information moves traditionally higher beta risk markets. 

• We will detail spread moves below, but tightening has continued to be evident across major sectors, with credit curves compressing in the grab for risk.

We attributed the moves to various projected areas of policy in the new administration last month, and those have not been dislodged. 

• Growth positives from projected moves to de-regulate markets and the economy, with banks in particular expected to benefit. 
  • A more constructive backdrop for M&A has also been contemplated. 
• Growth positives from potentially lower tax rates. 
• The potential impact of tariffs and immigration policy have been less positively priced, responsible for some poignant day to day moves – especially in rates – mainly following Trump tweets and cabinet hires. 

In summary, the key impact on securitized markets since our last note has continued to be the incoming administration, with new economic data seemingly uninspiring for risk takers. 

As we rapidly progress into year end, and activity levels are diminishing by the day, contributing to the plateauing effect we have observed in spreads and overall valuations in securitized markets. 

Against this backdrop, spread moves for some representative securitized credit markets can be observed below:

Agency RMBS, which is not depicted above, has been one part of the market that has experienced more definitive weakness, at least on a MTD basis here in December. 

• OAS are only +2bps wider to 43bps in the MBS component of the Agg, but the -15bps of associated excess returns lags badly the +40bps in HY, +24bps in IG corps and +22bps in NA CMBS. And recall, this is with lower implied vol, typically a nice catalyst for agency markets to rally. 
• We attribute the weakness as correlating to the MTD rise in rates; while implied vol has remained lower, the realized vol has caused some weakness in investor sponsorship recently. 

Also, to follow-up on a couple of key items that were on our mind amidst the strong post-election rally: 

• Should the outperformance of CMBS, which is the top performing sector YTD in the Agg, continue? Higher rates (10yr +66bps YTD) are typically not the sector’s friend, but are tighter spreads and continued economic growth enough to offset them? Yes, has been the somewhat emphatic answer from market participants. Optimism for strong reception for commercial real estate risk has driven continued outperformance here. 
• Are CLOs in the clear? Does the higher growth backdrop help reduce perceived credit risk for underlying borrowers, alongside lower front-end rates? Will potential de-regulation of banks hasten their return as buyers of AAA-CLOs? On all fronts, the markets seem content to price optimistic outcomes here, and our research has come back supportive of the risks available in this sector, for the first time this year. 

Finally, turning to issuance, the historic year for primary markets is coming to a close. Our updated issuance table reflects the heavy volumes that markets have absorbed year-to-date, all-time highs in the case of ABS and CLOs:

Looking forward, we project a continued plateauing effect into year end and the 1-2 week lull as markets re-open. However, we are optimistic overall for the new year and, in particular, the opportunities that will be available in Q1 as supply picks back up against the backdrop of policy announcements from the new presidential and legislative regime. 

Happy Holidays and best wishes for a Happy New year! 

Voya Securitized Team