Securitized Credit Market Update

Typically one of the quieter months of the year, August had plenty to keep us engaged on. We processed lots of new information in securitized markets, mostly macro but some micro developments as well, which we will cover below. As narratives explaining market behavior continue to shift, catalyzed by a wide range of pending deadlines and events, it all sets up for an eventful September.

Macro Inputs 

• Fed: Despite no FOMC meeting, the Fed’s ‘Policy Symposium’ in Jackson Hole was what we deemed to be the most consequential macro input of the month.
  • Specifically, Chairman Powell’s signal that a rate cut was coming: "the shifting balance of risks may warrant adjusting our policy stance", citing rising risks to the employment/labor market side of the Fed’s dual mandate.
  • He also cautioned around inflation risks, signaling that the path forward would likely be deliberate from a rate policy perspective. This left us believing that rate cuts will be incremental (i.e. 25bps chunks) and remain data dependent.
  • Regardless of the tempered nature of the shift in policy stance, the market re-priced across a number of dimensions, with rates perhaps the most germane to securitized market dynamics. They rallied in a pronounced bull steepener, which has remained intact into September, at least through press time (just after the August payroll report, released 9/5).
  • Despite the fundamental risk posed by a weaker labor market, securitized markets have reacted favorably to the lower rate environment and outlook for cuts in the policy rate.
  • The favorable reception has been most recognizable in agency RMBS markets, which was – by far – the lead source of excess returns (+51bps) in the Agg in August.
  • However, the implications extend to non-agency mortgage sectors, both residential and commercial. In each instance, the prospect of lower policy rates translating into lower rate volatility and easier financial conditions has positive implications for prepayments and structural de-leveraging in these important sectors for securitized credit strategies.
• Economic Data: The timing of last month’s talking points allowed us to opine on the impact of the July labor report. If you recall, that was the one that first evidenced the weakness in labor markets cited by Powell in his consequential speech at Jackson Hole. It included massive downward revisions (-258K!) across May and June, which took 3M average payroll gains to multi-year low. Well, the August result was similarly weak.
  • A paltry +22K net new jobs added, pairing with a tick higher in the unemployment rate (4.3%) to cement the Fed’s pivot to near term rate cuts.
  • While we won’t get August inflation until next week, uncomfortably higher inflation data has and perhaps will continue to keep the likely pace of rate cuts on the deliberate side.
  • Also of note in the realm of economic data from our perspective, growth measures have evidenced some strength in the economy: Citi’s economic surprise index turned positive (+23 at press time) and the Atlanta Fed’s real time GDP forecaster is measuring 3% annualized growth for Q3.
  • While we suspect this reflects some of the robust corporate investment (AI driven) and fiscal stimulus, rather than consumer spending, it is supportive of credit spreads broadly.
• Policy: While policy risk continued to ‘creep’ in not-so-subtle ways into more and more parts of the economy and financial markets, it failed to impact conditions over the course of the month, generally speaking.
  • On the trade side, we see market estimates of the weighted average tariff rate of 15-20%.
  • On the fiscal side, we have seen evidence of corporations taking advantage of stimulative tax provisions in a growth positive way. We have observed only periodic bouts of concerns with US debt levels, with the recent bear-steepening pressure (earlier this week) tied more to other developed market economies having funding pressure in our estimation. However, we are not dismissive of this risk and highlight the end of month deadline for funding federal agencies.
  • The deregulation agenda is underway, as highlighted in recent talking points. More recently, we have observed a pick-up in M&A activity, perhaps evidencing a prong of deregulation in the US economy coming to fruition.
    • Of particular note, privatization of the GSEs has only continued to pick-up steam. With major implications for securitized markets, the administration suggests an IPO could occur by year end and have reportedly been scouting bank leads and even floating a name for a combined entity (Great American Mortgage Corporation, ticker ‘MAGA’). While announcements have been accompanied by assurances intended to minimize volatility (implied guaranty to remain), significant risk is accompanied by continuing to move at this pace. This piece of the policy puzzle is sure to unfold in coming quarters and be perhaps the most consequential in our markets.

• Rinse and repeat, at least for securitized. Yes, the narrative shifted in rates markets post Jackson Hole, as detailed above, and there are implications for that. However, liquidity remained strong and deep in securitized markets throughout August, dismissing the traditional trough in activity that we typically associate as we progress through the dog days and punch through the other side of Labor Day. Many of the same micro-trends and securitized market biases remained uninterrupted from prior months:
  • Primary markets remained the place to be. It continues to be the dominant place to source risk, and execution remains extremely efficient for issuers as we begin September (and the pipeline is formidable!). Aggregated activity across sectors can be observed below, which evidences progress towards another year of record amounts of issuance, despite April disruptions and the elevated rate environment – impressive for public market champions.
  • Secondary market trading volumes were closer to reflecting a more traditional end of summer slowdown. Measured month over month, activity was lower across sectors. With a particularly large pipeline of new deals slated for September, we anticipate volumes picking up this month, but for it to enjoy good reception and earn the term ‘seller’s market’.
• And just like the other summer months, spreads benefited, this time with CLOs and CMBS leading the way. ABS and non-Agency RMBS saw some components participate in the spread rally, but the sectors overall definitively lagged – see our spread table above for corroboration.
  • We found the rally in CLOs particularly interesting in August, in light of 2 developments that intuitively suggest to us spreads would have widened: a) the loan market traded lower in August (LSTA -0.23pts), which typically correlates tightly with CLOs; and b) the bullish flattening move in rates, which we associate with lower yield for CLOs and consequently less fresh demand. Despite these factors, demand remained robust, and the spread curve flattened. In the end, we don’t believe this represents an actionable distortion. Instead, we attribute the move to a renewed faith in economic growth that will benefit a larger part of corporate America, similar to the market spirit that pushed small caps higher during the month (see Russell 2000 +7%).
  • Also, in another example of the ‘rinse and repeat’ nature of what securitized credit markets demonstrated in August, the spread moves resulted in more compression across most risk dimensions. While these dimensions differ across the various sectors and within sub-sectors, the most ubiquitous is in the credit curve, where subordinate parts of the capital structure outperformed seniors - a classic characteristic of risk-on markets with deep liquidity. o Of note, this contrasted with behavior that we observed in corporate credit markets (see IG corps’ OAS +3bps wider, loans prices -0.23pts), where their respective rallies seemed to run out of steam in August and some de-compression was noted in those markets.
  • In a final remark on enduring themes in securitized markets, the buyer base remained locked-in during August, with total return-oriented buyers (money managers, hedge funds) driving the action. Insurers were also meaningful participants, although with less of an ‘edge’ than recent months, we believe reflecting seasonality rather than a change in risk posture. We continue to monitor for bank buyers to return in earnest, outside of CLO AAAs where their participation has been evident.

• While we reflect positively on what catalyzed the moves and surrounding dynamics in securitized, we are less convicted these moves can continue uninterrupted into September, a traditionally weaker month for credit risk performance and one that is going to see LOTS of new issue supply get delivered.
• When we layer in an ‘extended’ feel of valuations in equity and corporate credit markets, market moving economic releases and policy/geo-political related deadlines, our risk appetite is lower into the month.
• We like taking advantage of the deep liquidity still apparent in our markets to trim some premium priced floating exposures in certain sectors, as well as some of our recent vintage deep subs.
• However, spread premiums to other corporate credit markets remain apparent to us and relative value remains formidable, particularly when risk-adjusting our return profiles in various sectors and sub-sectors. So, we remain holders of ‘core’ risk positions and would be a buyer into most extended distortion scenarios we can plausibly see. 

We hope everyone enjoyed the summer and is able to usher in a comfortable fall. 

Voya Securitized Team