Securitized Credit Market Update

The countdown has begun! The next time you read these talking points (hopefully that is not being overly presumptuous), we will have – at least in theory – a new president and freshly established majorities in Congress. 

Less than a month away, the event is increasingly a dominant component in the conversation and is accompanied with an extraordinarily high degree of uncertainty regarding the outcome. 

• What are the policy priorities of each administration? How will the results of Congressional elections impact the policy agenda?? Who will win??? What will be the impacts on markets???? 

So where is this gripping uncertainty evident in markets?

Not so much in equities, with the S&P 500 +3.4% since our last talking points in mid-Sept, and now up to 46 record highs set this year along the way. 

Fixed income credit markets have also traded with a bullish tone (HY -28bps to 294bps, IG corps -15bps to 81bps), while acknowledging the sharp sell-off in USTs (10yr UST +38bps to 4.03%) over this same time frame. 

In the securitized space, in line with our expectations, concerns are evident nowhere, beyond the numerous and increasingly frequent conversations with market participants in the space. However, to be clear, we do not detect the palpable uncertainty impacting risk-taking sentiment in any corner of our markets. 

• We will detail spread moves (tighter) and the open nature of markets (heavy primary issuance) below that evidence this, but bottom line, the rally we dissected last month has continued to roll on across agency and credit sectors. 

More broadly, one place we would argue there is evidence of concern is within volatility indices, as the VIX (+25%, or 4pts to 21) and MOVE (+26%, or 27pts to 127) have both moved to elevated levels, and above the recent range, which contrasts noticeably to the good fortunes in credit risk markets. 

• Our interpretation is that the pick-up reflects hedging demand for a potential increase in market volatility stemming from the election, with investors unwilling to unwind long positions they expect to perform into a macro-backdrop they regard positively.

So, what do we view as key to the outlook for credit risk that has emerged in the last month? 

• As was the case last month, fundamentals. 
• The labor report for September had positive implications for economic growth in each key respect: a decrease in the unemployment rate (-0.1% to 4.1%), a more substantial month over month increase in payroll growth (+223k over +114k) and pick-up in average hourly earnings (+0.4% MoM, +4.0% YoY). These numbers constituted a surprise versus consensus expectations, fueling a strong (and ongoing) move higher in equity and rate markets.
• The CPI report for September posted its 6 th straight decline, with the headline level dropping to 2.4% YoY. However, core-CPI did unexpectedly tick higher to 3.3% YoY, with “super core” services (excludes shelter) the key culprit. 
  • Shelter costs indicated +0.2% MoM, finally moving lower (was 0.5% in August) to better reflect market-based measures of rent (Zillow, Apartment List, Yardi) which have been essentially flat for months. 
• Real time GDP trackers (which also taken into account other data readings) have responded favorably: the Atlanta Fed’s GDPNow tool is registering 3.2% as of 10/15. 

Taken together, these updated data points support the soft or even no-landing economic growth scenario within markets, challenging rate cut expectations but fueling appetite for credit risk. 

Getting into more securitized market specifics, we characterize developments since our last set of notes as positive, particularly on the credit side of the equation. 

• In agency RMBS markets, the move higher in rates has diminished demand after a strong mid-year run when rates were – you guessed it - rallying.
  • OAS has widened +4bps to 42bps in the MBS component of the Agg during the quarter. 
• Within credit sectors, conversely, appetite has been strong and deep with money managers and insurers leading the charge. Again, irrespective of the impending election and related uncertainty. 
• As usual, the degree of spread movement has varied degrees across sectors and across the capital structure. 
  • CMBS has continued to outperform and, while generally tighter, ABS and CLOs have lagged and even endured some pockets of weakness: benchmark ABS have just recently begun to participate in the rally, and CLO BBs are measuring wider, although we see a stronger bid having developed here. Like last month, non-agency RMBS has been somewhere in between but overall has absorbed elevated new issuance well. 
    • We attribute the outperformance of CMBS squarely to the improved economic outlook, which makes the refinance mechanism more efficient, taking onerous extension and/or default scenarios off the table for more loans. This is evidenced by the recently announced $3.5B SASB deal backed by the Rockefeller Center in NYC – the largest Office SASB deal since April ’22. We are watching with some degree of caution the rate move higher but are currently content to discount it given the market’s perceived likelihood of substantial rate cuts still priced in (~200bps by year end 2025). 
    • ABS initially lagged, perhaps a consequence of the sustained elevated pace of issuance, alongside some fundamental concerns regarding low-income borrowers into what was a moderating labor market. However, we have noted in recent days a surge in appetite for risk, better reflecting the overall appetite for credit risk that has been on display in corporate credit markets. We believe more compelling rel-val considerations finally kicked in to support new allocations here. 
    • The bid for CLOs has picked back up after lagging in late summer as the forward market for rates re-priced lower. With the seemingly stronger economic backdrop, paired with a slight reduction in expectations for Fed cuts, risk appetite for this floating space has again firmed. We discount the widening implied in our spread chart as ‘noise’ in market data sources. 
• Specific levels and recent moves can be observed on the following page:

Turning to issuance, which has been a theme in 2024 due to its dynamism and robust pace, has continued to be the place for action in securitized credit markets. 

• As noted last month, the upcoming election has reportedly added urgency from issuers to bring deals safely ahead of any related volatility or illiquidity. 
• A highly unofficial cut-off date for new deals the week of Columbus Day had been whispered. 
• As of press-time this has not been evident in any fixed income sector. While not unusual for this time of year (thicker holiday schedule, etc), the pipeline into November does have limited visibility. 

Our updated issuance table reflects the heavy volumes that markets have absorbed year-to-date:

Looking forward, we see the wisdom in hedging future potential volatility risk, particularly in lieu of selling high quality forms of credit risk to reduce risk. 

Recent data have gone further to support credit risk taking in securitized credit sectors, with our cautious outlook for CLOs in-particular challenged by our seemingly still energized economy.

As always, we will keep our eyes on shifting rel-val considerations within and between sectors and scan closely for potential bouts of illiquidity for opportunity. 

Best of luck in the markets and navigating election week! 

Voya Securitized Team