Third quarter GDP growth rebounds, Q4 data solid
- U.S. GDP growth rebounded to a solid +3.5% pace in Q3, aided by a rebound in inventory building and a spike in agricultural exports. Personal consumption grew at a strong 3.0% pace during the third quarter.
- The labor market remained robust. Employers added an average of 165,000 jobs per month in Q4, and the unemployment rate fell to 4.7% in December. Average hourly earnings rose at a 3% pace during the quarter.
- Consumer confidence rose to a 15-year high in December, boosted by job gains, real wage growth, and stocks at record high levels.
Trump's surprise win makes fiscal stimulus likely
- Donald Trump’s surprise win in the Presidential election raised the prospects for significant fiscal stimulus in 2017, including tax cuts and infrastructure spending.
- While estimates vary, conservatively Trump’s proposals could be worth $150bn per year – 0.8% of GDP – or more, once fully phased-in.
- With the U.S. economy already running close to capacity, fiscal stimulus seems likely to add to already building inflation pressures.
Fed raises in December, expects three hikes in 2017
- As expected, the Fed raised its policy rate by 25 basis points (0.25%) at the December Federal Open Market Committee (FOMC) meeting, to a target range of 0.50% to 0.75%.
- Headline inflation gauges rose in the fourth quarter, boosted by the continued normalization of energy prices. Headline CPI rose 1.7% over the 12 months ending in November, while core inflation (excluding food and energy) rose 2.1%.
- The Fed’s dot plot forecast released at the December FOMC meeting showed participants expect three hikes in 2017, though only half had explicitly incorporated fiscal stimulus into their forecasts as yet.
Bond yields soar, stocks rise amid stronger data, post-election optimism
- Stocks rallied and bond yields jumped post-election as a wave of optimism for faster economic growth poured over financial markets following Trump’s surprise election win.
- Energy, financials, and construction-related businesses led the rally on expectations for a more favorable business environment under the Trump Administration and an infrastructure spending package.
- Brent Crude oil rose over 15% during the quarter to over $55/bbl, buoyed by the formal ratification of OPEC’s production cut, as well as news that several major non-OPEC nations planned voluntary cuts to their production as well.
Treasury yields soar, credit sensitive assets rally on growth optimism
- Donald Trump’s surprise election win prompted a strong rally as investors weighed the likelihood of fiscal stimulus, including tax cuts and infrastructure spending. Stocks rallied strongly and the U.S. dollar rose to a 14-year high versus other major currencies.
- U.S. Treasury yields jumped by 40-85 basis points (bps) across the yield curve as the market absorbed both solid incoming economic data and the prospect of significant fiscal stimulus in 2017. The 10-year U.S. Treasury rose 85bps to end the quarter at 2.44%. For the year, however, most Treasuries posted positive returns as rates largely round-tripped.
- Investment grade corporate spreads tightened during the quarter, significantly outperforming similar-duration Treasuries (+185bps). Basic industries, energy and insurance names led the rally. Over the last 12 months, investment grade corporates outperformed Treasuries by +493 bps.
- Agency MBS lagged U.S. Treasuries during the quarter as the spike in interest rates led to higher hedging costs. Net supply remained low, with the Federal Reserve continuing to absorb most new supply. For the trailing 12 months, MBS underperformed Treasuries by a modest 11bps.
- ABS returns were essentially flat over the fourth quarter. New supply remained healthy and a widening of swap spreads in December were modest drags on performance. Over the full year, ABS generated a healthy +98bps of excess return versus U.S. Treasuries as collateral quality remained strong and investor demand for shorter, high quality assets led to tightening spreads.
- CMBS spreads tightened modestly during the quarter. Tighter spreads and yield carry produced +46bps of excess returns versus Treasuries over Q4. For the full year, CMBS benefitted from strong underlying collateral performance and robust investor demand. During 2016, the sector outperformed U.S. Treasuries by +236bps.
Credit benefits from "Trump rally"
- Corporate bonds rallied during the fourth quarter as the “risk-on” rally sparked by Trump’s surprise election win boosted optimism over tax cuts and the prospect for faster growth.
- The option-adjusted spread (OAS) of the Barclays U.S. Corporate Index tightened 15bps during the quarter, generating +185bps of excess return versus similar duration U.S. Treasuries.
- Energy and construction-related names rallied on the prospect for fiscal stimulus and a more favorable regulatory environment for fossil fuel producers. Banks and insurance companies benefitted from rising interest rates and the prospect for a rollback in financial regulation.
Record issuance for 2016, policy proposals bear watching
- Investment grade new issuance totaled $205 billion over the final quarter of 2016, enough to push 2016’s full-year tally to a new record of nearly $1.3 trillion.
- Several aspects of the tax reform proposals offered by the incoming Administration could have meaningful implications for corporate debt issuance. These include eliminating the corporate tax deduction for bond interest and a one-time tax holiday for U.S. companies repatriating profits kept offshore.
Spike in interest rates, volatility, prove too much for agency MBS
- The S&P CoreLogic Case-Shiller 20-City Home Price Index posted a 5.10% year-over-year increase through October. Annual gains in home prices have averaged about 5% since mid-2014, and the 20-City Index is now within 7% of its pre-crisis peak.
- The Freddie Mac Weekly Survey Rate of 30-year mortgage rates rose sharply to end the year at 4.32%, the highest level in nearly three years.
- The Mortgage Bankers’ Association’s Refinancing Index, which had risen modestly since the start of 2016, fell back to a multi-year low, suggesting benign refinancing activity looking ahead into 2017 if rates remain elevated.
CMBS new issuance still muted; outlook mixed
- Despite a decent final quarter which saw $27 billion in new issue, CMBS issuance for 2016 still finished the year about 30% lower versus last year’s pace. Full-year CMBS new issue supply was $69 billion in 2016, versus over $97 billion in 2015.
- The outlook for CMBS new issuance in 2017 remains clouded by the impact of new risk retention rules for the issuer community which went into effect in late-2016.
- For the full year 2016, ABS issuance was just shy of $165 billion, nearly even with 2015’s level ($167 billion).
- Consumer credit performance remained strong during 2016; however, at this point in the cycle, market expectations are for some deterioration going forward.
The information contained herein reflects the views of Galliard Capital Management, Inc. and sources believed to be reliable by Galliard as of the date of publication. No representation or warranty is made concerning the accuracy of any data and there is no guarantee that any projection, opinion, or forecast herein will be realized. The views expressed may change at any time subsequent to the date of publication. This publication is for information purposes only; it is not investment advice or a recommendation for a particular security strategy or investment product. FOR INSTITUTIONAL INVESTOR USE ONLY. © Galliard Capital Management, Inc.