How will the markets perform?
As long as the US economy advances at this rate, the Federal Reserve will not be in a hurry to cut but the prevailing narrative requires a strong leap of faith on the US economy. The comment by Carlo Benetti, Market Specialist of GAM (Italy) SGR
Fueled by service costs, U.S. producer prices were higher than expected. The increase, which follows an increase in consumer prices which was also above expectations, highlights the sticky nature of inflation and further complicates the overall picture. As the idea that falling inflation was an incentive for the Fed to proceed quickly with rate cuts faded, markets found themselves forced to scale back expectations and prices. Retail sales also disappointed, falling more than expected (-0.8%), but the overall health of the American economy remains reassuring. Above all, the growth in consumer confidence continues, the University of Michigan Index rose to 79.6 compared to the previous 79, a modest increase which however continues a string of consecutive increases.
THE RISKS: INFLATION AND RATES
The real risk to deal with is that posed by possible surprises in inflation and rates. As long as the American economy advances at these rates, the Federal Reserve will not feel any urgency in reversing monetary policy, last Thursday Atlanta Fed President Raphael Bostic said he is not convinced that inflation is heading safely towards the 2% target. On the other hand, the prevailing market narrative calls for a strong leap of faith in the US economy, that it remains neither too hot nor too cold, that the Federal Reserve maintains its commitment to cuts, that there is no serious slowdown in the economy . It could happen and, equally, it could not happen.
THE AMERICAN ECONOMY IS STRONG, BUT…
The good reasons to believe in the favorable scenario are in the strength of the American economy. Historically, however, "goldilocks" scenarios have been imagined more often than they have actually come true, more often than not something gets stuck, something else escapes predictions, some unforeseen event happens and in the end expectations fade away. turn into disappointments.
The appointment with the recession has not been missed, it is most likely just postponed, the prospect for the second half of the year is a slowdown in economic activity, the bites of the monetary tightening will reach the economic system, during the course of the year will also exhaust the forced saving of American families, which is also concentrated in the high income brackets, the long-term forces will weigh on growth and the real rate of returns. At these levels of yield the bonds have returned to performing their function of capital protection. A sub-sector of the bond market with which to extend portfolio diversification is that of mortgage securitisations. Sixteen years ago, the unscrupulous use of securitizations was the trigger of the Great Financial Crisis but since then everything has changed, volumes have tripled, in the United States securitizations are worth almost eleven trillion dollars, the second most liquid market after that of Treasury.
MBS BONDS ON THE MARKETS
At this particular moment in the economic cycle, MBS bonds show some interesting aspects. Once the shocks that interest rates have imposed on the real estate sector have been overcome, the construction of new residential homes has started to grow again but is still not sufficient to satisfy demand. It is reasonable to expect “strong support for house prices even in the event of a substantial economic recession”. The probable medium-term scenario is that of a moderate decline in mortgage rates and a stabilization of prices.
A segment of mortgage securitizations of particular interest at this stage is that of senior securities, issues that occupy the highest part of the capital structure guaranteed by older and depleting mortgages. The holders of these mortgages have already repaid a large part of them and have every interest in continuing to do so, even in conditions of possible financial stress. In the event of a decline in home prices, or a recession, this segment is structurally more protected from default risk than more recently issued mortgages.
THE PROSPECTS OF SECURITIZATIONS
The prospects of securitisations are favored by at least three factors:
- the spreads are favorable, they allow you to realize capital gains in addition to the "carry";
- the mortgage loans underlying the “senior” issues are solid: mortgage loans dating back to before 2009 have seen a strong appreciation in house prices in recent years, the increase in the asset value of the underlying house improves the performance of the mortgages by reducing levels of arrears;
- current economic conditions are characterized by low unemployment, low household debt, high level of savings; conditions that support the creditworthiness of the securities.
The MBS bond market is also naturally sensitive to rate dynamics, however, at this moment, the width of the spreads is higher than that of corporate bonds of the same maturity and creates adequate safety margins.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/mercati-economia-americana-inflazione-tassi/ on Sun, 25 Feb 2024 06:49:49 +0000.