Morning Report: The Fed is in a bind

Vital Statistics:

S&P futures3,942-2.5
Oil (WTI)65.67-1.07
10 year government bond yield 3.38%
30 year fixed rate mortgage 6.42%

Stocks are lower as investors digest the Credit Suisse deal. Bonds and MBS are up.

Credit Suisse was bought by rival UBS over the weekend at less than half of its closing price on Friday. The deal includes a credit line from the Swiss National Bank, which will also share in some of the credit losses if necessary. There is no shareholder vote for either side. The AT1 bonds (sort of like the CRT bonds Fannie and Freddie issued) will get wiped to zero, but the rest of Credit Suisse’s bonds should get paid off. Those bonds were widely held in Swiss pension funds, so that is really who is getting bailed out here.

New York Community Bank has agreed to purchase some of the assets of failed Signature Bank. The branches in New York will be re-branded as Flagstar. It looks like this rescue will cost the FDIC about $2.5 billion.

It still doesn’t look like anyone wants Silicon Valley Bank. A few observers considered Silicon Valley Bank to be in the subprime bank loan business, making loans to companies with good ESG scores that hemorrhaged cash. Regardless of how the Administration tries to spin it, this was a bailout of the US tech sector.

Global central banks have put together a dollar swap facility to improve liquidity in the banking system. It would “serve as an important liquidity backstop to ease strains in global funding markets, thereby helping to mitigate the effects of such strains on the supply of credit to households and businesses.”

The week ahead will be all about the Fed meeting on Wednesday. As I discussed in my latest Substack article, the Fed is in a bind here. It is playing with fire if it continues to raise rates, yet inflation is nowhere near fixed. The real estate component of inflation is about played out, but the labor market remains tight.

Here is an excerpt from that piece:

The Fed (and global central banks in general) have painted themselves into a corner. Raising rates have blown up parts of the banking sector and they are playing with fire if they keep hiking. On the other hand, the labor market remains tight as a drum and workers are in the driver’s seat. The Fed was hoping to get unemployment up around 5%. That doesn’t appear to be in the cards. The Fed is probably going to have to start easing despite bad inflation numbers, and there is not a damn thing they can do about it.

Think about this: Treasuries have fallen far enough to blow some holes in banking balance sheets, and real interest rates are still negative. Sovereign Debt is wildly overvalued and valuations are still in bubble territory.

The Fed Funds futures see a 2/3 chance of a 25 basis point hike this week and a 1/3 chance on no hike. They also see that hike being reversed at the June meeting and three rate cuts by December.

The dot plot will be a wild card in this report. In December, the Fed saw the Fed Funds rate above 5% by the end of 2023. The Fed Funds futures see rates about 125 basis points lower. This will be the real wild card in the Fed meeting. If the Fed still has a dot plot that looks like the one below, then markets will have a conniption.

The big question for the mortgage business is what happens to MBS spreads? MBS spreads have blown out since the start of this banking crisis, although that probably has more to do with interest rate volatility than anything. The bond market just got whipsawed big time between the higher-than-expected inflation numbers and then the round of bank failures.

If RMBS were the asset class that blew up a lot of these banks, then it probably means that there will be supply as banks bite the bullet and try and unload paper to put into short term Treasuries. That can’t be good for mortgage rates, although I wonder if there simply isn’t going to be much of a bid in the market for 3% UMBS.

One other thing that is a given is that the party in the MSR space is over. If rates are falling, then servicing valuations will be falling too. There are a lot of people out there marking their servicing portfolios at 5.5x or higher.

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