Morning Report: Corporate credit spreads are widening

Vital Statistics:

			Last	Change
S&P futures			2621	15.3
Eurostoxx index			375.48	0.66
Oil (WTI)			62.54	0.48
10 Year Government Bond Yield				2.79%
30 Year fixed rate mortgage				4.43%

Stocks are up to start the week after a pretty lousy session on Friday. Bonds and MBS are flat.

The week after the jobs report is usually pretty data-light, however we will get the Producer Price Index and the Consumer Price Index on Tuesday and Wednesday. 

Friday's jobs report should allay investor fears that the Fed is behind the curve, at least according to PIMCO's Mohammed El-Arian. The light payroll number was probably weather-driven and the 3 month average is around 200k, which is solid and respectable. Wage growth came in as expected. Investors should take comfort that the Fed is probably not at risk of making a policy mistake due to an overheating economy. His view is that there is a 65 / 35 percent chance the Fed will stick the landing, meaning that economic growth will continue to more broadly expand and that markets will adapt to the higher volatility associated with normal monetary policy.

An example of higher volatility: corporate bond spreads. The end of 2017 was characterized by extremely low volatility in the stock and bond markets. When volatility falls, risk premiums contract. We saw corporate credit spreads reach pre-crisis levels. Since the beginning of the year, they are back to widening. Bad news for corporate bond funds, which have been beset by widening spreads and higher rates. 

The story of the past couple of years has been "subprime auto." The chickens are coming home to roost on this trade, and we are starting to see some subprime auto finance companies go bankrupt. Indeed, when you talk about the effects of low volatility in the market, things like this come to mind. With rates being held down by Fed actions, investors inevitably reach for yield. For a while, you could get a lower rate on a 6 year auto loan than you could on a 30 year fixed rate mortgage. This is insane when you take into account that the value of the collateral underlying a mortgage is 90% sure to increase over time, while the value of the collateral underlying the car loan is 100% sure to depreciate over time. That said, this won't be a repeat of 2008 economically. 

Mortgage credit got tighter in March, according to the MBA's Mortgage Credit Availability Index. It was most pronounced in government lending, which could have been explained by some of the weakness and illiquidity we were seeing in the higher coupon Ginnie securities. Ginnie investors have been burned by higher prepay speeds and have been reluctant to buy the higher coupon securities. This makes the higher note rates (which is where the lower credit scores usually reside) cut off from the rest of the market.