DesertXpress will be able to use the money to pay for the 135 miles of the project located within the state of California. This includes the costs of design, development, construction, operation and maintenance of the rail system itself; a passenger station; a maintenance facility; train cars; and electrification infrastructure. DesertXpress will also be able to use the bonds, which are sponsored by the California county of San Bernardino, to establish a debt service reserve fund, as well as pay for interest and other bond-related expenses. While total spending is listed at around $4.8 billion, “hard construction costs” are $3.6 billion.
Construction, which is expected to begin in the second half of 2020 and wrap up in 2023, according to an IBank staff report, will generate more than 15,800 temporary construction jobs.
Of course, you have to drive from Los Angeles across the mountains north of LA to get to Victorville, park your car and get on the high speed train to Las Vegas. THEN get cab or Uber to your final destination. Odd, since you can fly from LAX to Las Vegas for $39 each way.
But it will produce 15,800 part-time jobs … at a cost of $291,139 per job created. Yikes!
As the US Treasury 10-year yield approaches 2% … again, we begin to worry about issues such as extension risk and convexity risk (collectively known as “The Wings”) given their propensity to drive hedging.
Extension Risk
Historically, the risk of sudden yield curve movements has greatly affected the market for MBS, which represent claims on a pool of underlying residential mortgages. The interest rate risk of MBS differs from the interest rate risk of Treasury securities because of the embedded prepayment option in conventional residential mortgages that allows homeowners to refinance their mortgages when it is economical to do so: When interest rates fall, homeowners tend to refinance their existing loans into new lower-rate mortgages, thereby increasing prepayments and depriving MBS investors of the higher coupon income. However, when rates rise, refinancing activity tends to decline and prepayments fall, thereby extending the period of time MBS investors receive below-market rate returns on their investment. This is commonly known as “extension risk” in MBS markets.
Duration and Convexity The effect of the prepayment option can be seen in the chart below, which displays the relationship between yield changes (x-axis) and changes in the value of an MBS (black) and a non-prepayable ten-year Treasury note (red). The sensitivity of each instrument to small changes in yields (essentially the slope of each yield-price relationship at the point at which the MBS was last hedged, indicated by the dashed line) is known as the effective duration, while the rate at which duration changes as yields change (the curvature of the price-yield relationship) is known as its convexity. In the example shown below, the MBS and Treasury security are duration matched in the sense that they will tend to move one-to-one for small changes in yields.
When interest rates increase, the price of an MBS tends to fall at an increasing rate and much faster than a comparable Treasury security due to duration extension, a feature known as the negative convexity of MBS. Managing the interest rate risk exposure of MBS relative to Treasury securities requires dynamic hedging to maintain a desired exposure of the position to movements in yields, as the duration of the MBS changes with changes in the yield curve. This practice is known as duration hedging. The amount and required frequency of hedging depends on the degree of convexity of the MBS, the volatility of rates, and investors’ objectives and risk tolerances.
Duration hedging of MBS can be done with interest rate swaps or Treasury bonds and notes. When rates decline, hedgers will seek to increase the duration of their positions. This can be achieved by buying Treasury notes or bonds, or by receiving fixed payments in an interest rate swap. Conversely, MBS holders will find the duration of their MBS extending when rates increase, which they may choose to offset by selling Treasury notes or bonds, or by paying fixed in swaps. If sufficiently strong, this hedging activity can itself cause interest rates to rise further, and further increase duration for MBS holders, inducing another round of selling of Treasuries.
A Convexity Event Averted A sudden initial rise in medium- to long-term rates can therefore trigger a self-reinforcing sell-off in Treasury yields and related fixed income markets, fueled by MBS hedging—a phenomenon known as a convexity event. During a convexity event, MBS hedgers collectively attempt to decrease duration risk by selling Treasury securities or paying fixed in swaps. The two most important factors that determine the likelihood of a convexity event are the size of the MBS portfolio held by duration hedgers and the convexity of that portfolio. The large-scale purchases of MBS initiated by the Federal Reserve in November 2008 as part of the post-crisis LSAPs have had a profound impact on both these determinants.
MBS investors, broadly speaking, fall into two categories: those holding MBS on an unhedged or infrequently hedged basis and those that actively hedge the interest rate risk exposure. Unhedged or infrequently hedged investors include the Federal Reserve, foreign sovereign wealth funds, banks, and mutual funds benchmarked against an MBS index. MBS holders who actively hedge include real estate investment trusts (REITs), mortgage servicers, and the government-sponsored enterprises (GSEs).
Mortgage bonds are often held by large investors such as money managers and banks. They tend to prefer stable returns and constant duration as a means to reduce risk in their portfolios. So when interest rates drop, and mortgage bond duration starts to shorten, the investors will scramble to compensate by adding duration to their holdings, in a phenomenon known as convexity hedging. A hedge is basically investing in something that tends to go up when the first thing goes down (or vice versa). To add duration, so as to extend payments into a longer period, investors could buy U.S. Treasuries, which would further push down yields in the market. Or they could use interest-rate swaps, which are a contract between two parties to exchange one stream of interest payments for another.
Here are the dollar swaps and US Treasury actives curves today and from December 2005 to illustrate the decline in both curves of around 300 basis points at the ten year tenor.
Today’s US Treasury curve upward sloping … again having retreated from the inverted curve.
Here is a snap shot of MBS hedge ratios by coupon.
Of course, interest rates are influenced by the Voodoo Children themselves, the Central Banks like The Federal Reserve.
As Europe shows signs of economic life and US recession fears dim, we are seeing an exodus from long-dated Treasuries and a large turnover in gold futures. But are markets expecting more active intervention by The Fed? (Aka, Fed Monkey).
(Bloomberg) — Investors are pulling the plug on a strategy tracking long-dated Treasuries as U.S. stocks trade near all-time highs.
The iShares 20+ Year Treasury Bond exchange-traded fund, ticker TLT, posted its worst week of outflows on record, with traders yanking more than $1.2 billion, according to data compiled by Bloomberg. The 10-year U.S. government bond yield soared in the span, approaching 2%.
Meanwhile, gold futures fell to a three-month low as contracts equal to over 3 million ounces changed hands in half an hour on the Comex.
In the 30 minutes ended 10:30 a.m. in New York Monday, 33,596 contracts were traded, more than triple the 100-day average for that time of day. Futures have declined in recent weeks as growth concerns ebbed, damping haven demand for the precious metal.
With inflation expectations rising, will Uncle Jay’s Band intervene even more than they have at recent FOMC meetings?
IF inflation rises, The Fed may be tempted to raise rates. But will it be enough to justify a rate increase at the December FOMC meeting?
(Bloomberg) — The bond market may be about to get confirmation of its rebounding inflation wagers, according to Vanguard Group Inc. strategist Anne Mathias.
The $5.6 trillion asset manager is among proponents of the view that market-based measures of inflation expectations will extend their climb from a three-year low.
Potential progress in U.S.-China trade negotiations has been a key contributor, along with the Federal Reserve’s signaling on Oct. 30 that it would need to see a significant pickup in inflation before lifting rates.
Five-year breakeven rates — a proxy for anticipated annual increases in consumer prices into 2024 — touched a four-month high of 1.64% last week, with nominal yields surging as well. Developments on the trade front aside, bond traders’ bearish shift may now hinge on inflation data to be released this week.
Treasury Inflation Protected Securities (TIPS) have been on the rise in 2019 as inflation has been rising.
And the interest rate volatility cube is lighting up!
While the S&P 500 and Dow Jones Industrial Average hover near all-time highs, something is brewing .. and it smells like fish stew (or fish tacos at Brion’s Grille).
The Dow market-neutral momentum (blue line) is plunging and it coincides with short-momentum gains (red line).
Momentum ETFs are seeing a large outflow.
MTUM, the iShares Momentum Factor ETF, has seen large outpourings of funds.
I wonder if the Atlanta Fed’s GDP NOW forecast of 1% GDP for Q4 2019 has anything to do with the exodus from Momentum indices?
Federal Reserve Chair Jerome Powell has said that the US economy is in a good place, and further rate cuts are not warranted. That is, Trump can’t turn The Fed loose.
Various US Treasury yield curves are un-inverting and are all positive.
The Treasury actives curve is no longer sagging, but the Dollar Swaps curve continues to sag.
But in terms of Treasury futures, the volatility for 2 year, 10 year and 30 year (Ultra) contracts are progressively warping for 10 Delta Puts as maturity increases.
Of course, the yield curve can revert to a negative state if … the China trade agreement becomes unglued, Democrats succeed in impeaching President Trump, etc.
Subprime mortgages (that is, loans made to subprime borrowers) are like the dinosaur — extinct. But as Ian Malcolm said in the movie Jurassic Park … life finds a way. They simply morphed into a less-threatening sounding product: the non-qualified mortgage (NQF).
(Bloomberg) The subprime mortgage-backed bond may be dead in America a decade after it helped trigger the global financial crisis, but a security with some of the same high-risk characteristics is starting to take off.
It’s called the non-qualified mortgage — basically a loan granted to borrowers whose checkered financial record made them ineligible for conventional mortgages.Lenders have bundled more than $18 billion worth of these loans into bonds this year that they then sold to investors, a 44% increase from 2018 and the most for any year since the securities became common post-crisis.
This surge in issuance of non-QM bonds, as they’re called, comes just as some initial indications of delinquency rates on the loans are starting to emerge. The short answer: They’re high. About 3% to 5% in some bonds, according to Barclays Plc. That’s multiples of the current 0.7% delinquency rate on Fannie Mae loans.
And while no one is saying these bonds are in danger of defaulting any time soon, their newfound popularity does reflect the growing risk that yield-starved investors are taking to boost returns at a time when the U.S. economy is slowing. It’s similar to the way demand for junk bonds and securities backed by fast-food franchises and private credit have all surged this year. In the case of non-QM bonds, coupons on the debt can be north of 5%. A typical Fannie Mae mortgage bond sold nowadays has a coupon closer to 3.5%.
“It’s obviously disturbing this late in the cycle to see originations for these loans at the kind of level they’ve kicked up to,” said Daniel Alpert, managing partner at Westwood Capital. “The housing market is not quite ready for a big infusion of this product.
The non-QM bond market is for now, at least, way too small to cause the kind of broader disruptions that subprime bonds did when they soured en masse a decade ago. (That’s what she said!) Moreover, the bonds are built to withstand tougher housing downturns than they used to be, and the borrowers aren’t as risky. The securities may face some sort of hit if the housing market weakens, but it won’t be severe, Alpert said.
“It’s not the subprime we remember from 2006 to 2007,” said Mario Rivera, managing director of the Fortress Credit Funds business, which has bought non-QM bonds. “It’s more of a second or third inning of non-QM. We’re getting the best collateral before the more aggressive lending comes in.”
Issuance of bonds backed by non-qualified-mortgages is surging
Source: Sifma, Bloomberg. Figures for 2019 are through Oct. 31
But fund managers’ willingness to plow money into these securities shows how the intense suspicion that met mortgage bonds after the housing bubble burst last decade is starting to slowly fade. The subprime mortgage crisis triggered hundreds of billions of dollars of losses for investors.
There are more than $27 billion of outstanding bonds backed by non-qualified mortgages now, a small fraction of the approximately $10 trillion mortgage-bond market. In 2007, there were around $1.8 trillion of bonds backed by loans to non-prime borrowers.
The “non-qualified” moniker refers to any mortgages that don’t meet rules from the Consumer Financial Protection Bureau that went into effect in 2014. Many investors and issuers expect the market for non-QM bonds to grow. A temporary rule that lets Fannie Mae and Freddie Mac buy some home loans that don’t meet all the qualified-mortgage rules is set to expire in 2021. That will result in more debt being available to be bundled into non-QM bonds. Redwood Trust Inc., which issues mortgage securities, estimated in May that some $185 billion of home loans bought by the government-backed agencies annually would be considered non-QM.
JPMorgan, Angel Oak
A handful of lenders, including JPMorgan Chase & Co., Angel Oak Capital Advisors and Caliber Home Loans have been making the non-qualified mortgages and bundling them into bonds.
Borrowers’ scores in non-QM bonds are typically lower than what’s seen in other mortgage securities without government backing, like credit-risk transfer securities. But the consumers typically have relatively small debt loads compared with their incomes and the value of their homes. In many recent deals, non-QM borrowers have average credit scores in the low to mid 700s, a level credit reporting groups generally deem “good” to “very good.” Subprime borrowers typically have scores of 660 or less.
The bonds themselves also have more safeguards for investors than they used to. According to a Fitch Ratings analysis, an average of 36% of principal would have to be lost before the top-rated slice took a hit. The cushion in crisis-era “alt-A” bonds with the same rating was just 6%.
“There’s a lot more cushion, as there should be,” said John Kerschner, head of U.S. securitized products at Janus Henderson Group Plc, which manages $360 billion. “You can get some comfort that even if defaults inch up, the losses from those defaults aren’t going to be egregious.”
Real Risk
But even if non-QM bonds aren’t toxic, they have real risks. Many borrowers with non-qualified mortgages offer lenders bank statements to verify income instead of more stringent tax returns. Fitch says such documentation may offer only partial verification, and these borrowers could have unstable income because, for example, they own small businesses.
Making non-qualified mortgages can be legally riskier for lenders. If a borrower misses payments, and it turns out they shouldn’t have received the loan in the first place, they can sue the lender or even the securitization trust that owns the loan. Qualified mortgages have more legal protections for lenders and bondholders.
The strength of the housing market has helped support the bonds for now. Home-price appreciation has slowed over the past year, but the average U.S. house value still rose more than 2% in August from a year earlier, according to S&P CoreLogic Case-Shiller data. In a downturn similar to the financial crisis, when home prices contracted around 34% between 2006 and 2012, Barclays expects only the riskiest, lowest-rated portions of most non-QM bonds to lose money.
That’s partly why Barclays says the top-rated portions of non-QM bonds are a good buy at current prices. (Famous last words!) The notes tend to pay down quickly, because borrowers refinance into more conventional mortgages when they can. And the securities offer higher yield relative to alternatives like credit-risk transfer bonds.
“At least for now, credit concerns for most non-QM deals should be modest for investors who purchase the investment grade-rated classes,” Barclays strategist Dennis Lee wrote in a note in September.
That is, as long as there isn’t a home price bubble that bursts like in 2008. Like the stock market could.
US employment is out for October. The GM strike is over, but it crushed the manufacturing sector. But bartenders and restaurant waitstaff led the jobs addition.
Payrolls increased 128,000, topping estimates, and revisions added 95,000 jobs for the prior two months, suggesting the labor market remains broadly healthy
Wage growth rose 3% on an annual basis, and the prior month’s year-over-year gains were revised higher. While broadly decelerating, wages continue to support consumer spending and drive the record-long expansion forward
Today’s report is good news for the Federal Reserve and Chairman Jerome Powell. It supports Powell’s description of the labor market as “strong” and his view that the economy is in a good place
A few quirks in today’s report subdued what would have been a knockout number. The GM strike took a 41,600-job bite out of payrolls, while the roll-off of some temporary 2020 census workers shaved an additional 20,000
The unemployment rate edged up to 3.6%, which is still extremely low. It also reflected an influx of about 325,000 people into the labor market, which is a good thing
Where the jobs added were:
So, it looks like Powell and Richard Clardia, the Vice-chair of the Federal Reserve will view this jobs report as a reason to pause rate cuts.
The Dow jumped 250 points on the positive jobs report.
Meanwhile, there are jobs galore at establishments like Paddy’s Pub and Brion’s Grille on George Mason University campus!
The S&P 500 Index’s second fresh high this week saw the equity benchmark close just shy of 3,047 on Wednesday and continue its upward trajectory toward an overbought level.
Its GTI Global Strength Indicator — a smoothing oscillator showing the strength of a price — reached 66.5 intraday, the highest since mid-July. Earnings and Friday’s U.S. payrolls report may help to determine whether the technical gauge triggers its first sell signal since that month or remains in a neutral zone between 30 and 70.
Technical indicators are adored by many (just not academics). BUT if you believe in Bollinger Bands … the S&P 500 index (white line) is near the upper limit of its upper band (pink).
Do you believe in the Ichimoki Cloud? Currently, the NYA (New York Stock Exchange) is trading ABOVE the cloud.
How about the Hindenburg Omen? It was correct in signaling a market downturn way back in 2007, but has not really been a good forecast of market corrections since 2007.
Of course, The Federal Reserve impacts markets. As of today, the Fed Funds Futures market is predicting no rate cuts at the December FOMC meeting and no rate cut until the March 2020 meeting.
The then there is the China trade deal where China is indicating “no deal” unless the US rolls back more tariffs on Chinese imports.
