Securitized Credit Market Update

It has been many moons since our last set of traditional talking points, going back to mid-March. Loyal readers may recall the series of daily talking points from that eventful period after ‘Liberation Day’, which was deemed to obviate the need for our ‘traditional’ monthly installment. 

As conditions have “settled down” we have moved back to the monthly cadence… for now.

Macro Inputs

• Tariff Sheriff and Fiscal Policy: All is well! Or at least markets are pricing it as such, operating under the protective veil of various reprieves and a seemingly muted DOGE effort. Previously the dominant force within markets (important implications for inflation, Fed policy and economic growth), tariffs and trade have moved to the side as fiscal policy takes center stage. While fiscal policy under the new presidency has more pro-growth, business-friendly components, it is not without risk. Rates markets have been most keen on the associated risk of a potentially growing budget deficit and overall US debt burden. This concern coincided with Moody’s downgrade of the US, costing it its final Aaa rating from a major NRSRO, in which it cited concerns with America’s burgeoning debt burden. Trade wars still have the potential to shake markets, as evidenced by Friday’s (5/23) move in response to Trump’s tweet regarding tariffs on the EU and non-US manufactured Apple products. However, we sense fiscal policy as the more dominant force getting discounted into markets.
  • Despite the more direct feedback loops into securitized credit markets from higher UST rates, markets are well-behaved since April’s gyrations which we chronicled in a series of daily updates. Across securitized credit sectors (ABS, CLO, CMBS, Non-Agency RMBS/CRT), we have been pleased to see primary markets function with ease into the elevated rate environment. Unfavorable inflationary and/or growth impacts from across policy components (Tariffs, DOGE cuts, Fiscal) are in play, but these remain uncertain and not visible in remittance reports from securitized credit transactions across sectors. This helps promote smooth functioning in our markets, alongside generally favorable moves across equity and credit risk markets (May MTD: S&P 500 +4%, HY OAS -53bps, IG Corps OAS -15bps).
  • While not a securitized credit market, the agency RMBS market has been one place that has not enjoyed the shift to fiscal policy, as the upward move on UST rates has been received poorly here.  MTD, the OAS for the MBS portion of the Agg is +1bp wider versus the move tighter as highlighted above and in our spreads table below.
• US Labor and CPI: April Payrolls and CPI both came in favorably from our perspective, evidencing an economy that were not yet disrupted by new policy directives. The headline payroll # surprised consensus to the upside (+177K vs +138k expected) and the unemployment rate stayed stable (now is at 4.2%) - neither too hot nor too cold. CPI retreated, with the headline and core both posting downside surprises: headline +0.2% MoM vs +0.3% expected and core +0.2% vs +0.3% expected. The year over year headline measure (+2.3%) represented a 4yr low. In each case, market reactions were modest relative to policy driven moves highlighted above, but certainly contributed to the positive sentiment and repair in markets from April’s lows.
  • Similar to April, securitized markets had little to price after these reports, with market affinity for risk assessed as based more on greater comfort from trade war reprieves and a more growth friendly policy agenda. We continue to expect, however, that this hard data likely will keep the Fed on hold, not ideal for CMBS and RMBS where weaker associated refi impulses keep transaction de-leveraging on the slow side.
• Fed: While I expected more potential for market vol from a hawkish/stubborn Fed, a modest day over day rise in UST rates (10yr +10bps) was what I assessed as the only real immediate fallout. Equity markets continued to press higher. Chalk it up to a market content that rate cuts don’t need to be delivered with urgency, with that sentiment presumably linked to tariff reprieves. We would also be remiss not highlight the reprieve granted China that following weekend (5/10-5/11) as mitigating any ruminations on a stubbornly hawkish Fed.
  • Securitized markets (like other risk markets) prefer a dovish tone but are resigned to a receiving a hawkish message in light of uncertain policy impacts on inflation and growth. Also, we do not lose sight of the dynamic that ‘higher for longer’ policy rate is positive for front end yields, in particular floating rate and short duration parts of securitized (CLOs, CRT, ABS).

• As is mostly evidenced in the spreads table, securitized markets have traded tighter since our daily updates that depicted so much spread volatility. As alluded to, this apparent regime shift has been driven by the more growth favorable impact in policy initiatives, led by trade/tariffs and more recently by fiscal policy. As in the April sell-off, the rally back has been led by equities, which have approached (but not reached) all-time highs. Liquidity has improved dramatically, and securitized sectors have likewise participated in the rally/retracement.
• CLOs, CMBS and CRT has outperformed ABS and Non-Agency RMBS, although all sectors have seen spreads tighten into the improved policy backdrop. Liquidity is fully restored, as evidenced in resumed primary activity, as well as “normal” secondary flows across the universe, CLO ETFs included.
• Generally, the spread moves have favored subordinate parts of the capital structure across sectors. In our assessment, this reflects the market’s renewed confidence that recession can be avoided on the back of lower tariffs and fiscal support, irrespective of ‘higher for longer’ UST rates.
• From a buyer type perspective, total return oriented buyers (money managers, hedge funds) led the reversal in late April into mid-May (China reprieve). More recently, as rates have risen, we have seen insurance buyers and powering markets, attracted by higher yields available even as spreads continue to tighten. If you recall, insurers were not sighted as a standout force (buying or selling) in our March talking points or in our daily April notes, so their return is notable.
• As alluded to, primary market activity has fully resumed from the April disruption. Market participants at our most involved broker-dealers characterize conditions as “healthy” and “smooth”.
• In addition to that soothing assessment, we highlight the continued faster pace of issuance in CMBS (+97% YoY), evidencing the repair in that market following 2 years of crisis like conditions.
• Conversely, we highlight the sharp decline in CLO issuance, which has been at a slower pace throughout May, even as CLO debt spreads tighten. Discussion with market participants suggest the more muted pace is owing to the status of ‘the arb’, which has purportedly suffered as loan spreads (the underlying collateral) have retraced more quickly than CLO debt spreads.

Outlook

• We are gratified (and relieved!) by the retracement in spreads, as our cautious but ultimately encouraging outlook from March into the teeth of the volatility has proven meritorious, albeit stressful at times.
• The regime shift in US risk markets - away from US exceptionalism powered by consumer resilience and AI related corporate spending, and into a less certain outlook for economic growth – may still be under way. This is now further complicated by fiscal challenges inspired by the recently approved house version of the US budget.
• The duration of this environment, ultimately negative for credit spreads and excess returns, seems more likely play out over a “medium term” horizon, as the budget bill winds its way through Congress and tariff reprieves extend through July. In addition, the ultimate magnitude of such a regime shift on economic growth is highly uncertain with potential powerful policy forces still in the medium-term mix.
• We continue to promote focus within our team, relying on assessing our traditional pillars for investing (collateral, structure, parties involved, rel-val) as we navigate the policy inspired uncertainty. This is particularly the case in primary markets where robust issuance plans intersect with periods when liquidity is stretched (early to mid-April), assuming one’s underwriting remains focused and sound.

We hope everyone enjoyed their May and we all can have an enjoyable tariff free summer! 

Voya Securitized Team