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Tag: treasuryyields

  • Subprime car-loan rates are hitting 17%-22%. Should investors be worried?

    Subprime car-loan rates are hitting 17%-22%. Should investors be worried?

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    Many borrowers with subprime credit have been paying 17% to 22% rates on new auto loans this year as the Federal Reserve’s inflation fight takes a toll on lower-income households.

    That borrowing range reflects the average cost, or annual percentage rate, for a loan in recent subprime auto bond deals, according to Fitch Ratings, an increase from last year’s average APR of closer to 14%.

    Higher borrowing costs can mean households need to put more of their income into monthly auto payments, ramping up the risks of late payments, defaults and car repossessions. Those risks, however, have yet to make investors flinch.

    The subprime auto sector already has cleared almost $30 billion of new bond deals this year, according to Finsight, a pace that’s slightly below volumes from the past two years, but still above historical levels since 2008.

    The subprime auto bond market is revved up, even as borrowing rate soar


    Finsight

    “I do believe there has to be a reckoning if rates stay higher for longer,” said Tracy Chen, a portfolio manager on Brandywine Global Asset Management’s global fixed income team.

    Figuring out when the tumult might hit has proven difficult. Instead of slowing, the economy has shown resilience despite the Fed lifting its policy rate to a 22-year high of 5.25% to 5.5%. The central bank also indicated it might need to keep rates higher for some time to fight inflation. Longer-duration bond yields, as a result, have pushed higher, but still hover below 5%.

    Subprime standoff

    Inflation eats away at paychecks, especially those of lower-wage workers, a problem the Fed hopes to solve by keeping borrowing rates elevated. A gauge of inflation out Thursday showed consumer prices were steady at a 3.7% yearly rate in September, above the Fed’s 2% target.

    “This recession has been on everyone’s mind for the past three years,” Chen said. While she thinks the economy will likely contract in the middle of 2024, a lot of damage could be done before that. “The longer rates stay here, the harder the landing.”

    For now, the Fed is widely expected to hold rates steady at its next meeting in November. “Fed policy makers are now shifting their focus from ‘how high’ to raise the policy rate to ‘how long’ to maintain it at restrictive levels,” said EY Chief Economist Gregory Daco, in emailed comments.

    Stocks were flat to slightly higher in choppy trade at midday Thursday after the inflation report came in hotter than forecast, with the Dow Jones Industrial Average
    DJIA
    near unchanged and the S&P 500 index
    SPX
    up 0.2%.

    Past recessions and the burden of higher interest costs typically hit lower-wage workers harder, making subprime credit a canary in the coal mine for the rest of financial markets. Even so, investors in subprime auto bonds have yet to demand significantly more spread, or compensation, to offset potentially higher defaults among these borrowers.

    Related: Subprime auto defaults on path toward 2008 crisis levels, say portfolio managers

    Take the AAA rated 2-year slice of a new bond deal issued in mid-October by one of the subprime auto sector’s biggest players. It priced at a spread of 115 basis points above relevant risk-free rate, up from a spread of 90 basis points on a similar bond issued in August, according to Finsight, which tracks bond data.

    When factoring in Treasury rates, the yield on the bonds bumped up to about 6% and 5.7%, respectively. The shot at higher returns and low delinquencies in subprime auto bonds have likely helped with investor confidence. The rate of subprime auto loans at least 60-day past due in bond deals was about 5% in September, according to Intex, up from historic lows around 2.5% two years ago.

    “I think people still feel confident,” Chen said of subprime auto bonds. When putting a recent bond out on a Wall Street list to gauge its market value, she said bids come in right away.

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  • ‘Anxiety’ high as stock market falls, bond yields rise — what investors need to know after S&P 500’s worst month of 2023

    ‘Anxiety’ high as stock market falls, bond yields rise — what investors need to know after S&P 500’s worst month of 2023

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    U.S. stocks and bonds are both falling again, with the S&P 500 just wrapping up its worst quarterly performance in a year after another surge in Treasury yields. 

    “That creates a lot of anxiety,” as there’s still a fair amount of “investor PTSD” from last year, when markets were rocked by losses in both equities and bonds, said Phil Camporeale, a portfolio manager for J.P. Morgan Asset Management’s global allocation strategy, by phone.

    But it’s not the same environment.

    Last year was about the Federal Reserve rushing to tame runaway inflation with rapid interest-rate hikes after being “behind the curve,” he said. Now investors are grappling with a surge in Treasury yields after the Fed in September doubled its U.S. growth forecast this year to 2.1%, according to Camporeale, pointing to the central bank’s latest summary of economic projections.

    “This is your kiss-your-recession-goodbye trade,” he said, with sharp market moves in September reflecting the notion that “the Fed is not easing anytime soon.”

    The U.S. labor market has been strong despite the central bank’s aggressive tightening of monetary policy, with the unemployment rate at a historically low 3.8% in August. In September, the Fed projected the jobless rate could move up to 4.1% by the end of next year, below its previous forecast from June.

    “Inflation is falling,” Camporeale said. “The most important metric right now is the labor market.”

    As he sees it, investors are worried that the Fed will hold interest rates higher for longer should the unemployment rate remain low and the labor market “tight.” The Fed projected in September that it could raise rates once more this year before reaching the end of its hiking cycle, with fewer potential rate cuts penciled in for 2024 than previously forecast. 

    Investors expect to get a look at the U.S. employment report for September this coming week, with nonfarm payrolls data scheduled to be released on Oct. 6.

    See: Government shutdown averted for now as Congress approves 45-day funding bridge

    Meanwhile, the U.S. stock market ended mostly lower Friday, with the Dow Jones Industrial Average
    DJIA,
    S&P 500
    SPX
    and Nasdaq Composite
    COMP
    all closing out September with monthly losses as investors weighed fresh data on inflation. 

    A reading Friday of the Fed’s preferred inflation gauge showed that core prices, which exclude volatile food and energy categories, edged up 0.1% in August. That was slightly less than expected. Meanwhile, the core inflation rate slowed to 3.9% over the 12 months through August. 

    But headline inflation measured by the personal-consumption-expenditures price index rose more than the core reading on a month-over-month basis, as higher gas prices fueled its increase. 

    S&P 500’s worst month of 2023

    Investors have been anxious that the Fed may keep rates high for longer to bring inflation down to its 2% target. 

    Friday’s close left the S&P 500 logging its worst month since December, dropping 4.9% in September for back-to-back monthly losses. The S&P 500 sank 3.6% in the third quarter, suffering its biggest quarterly loss since the three months through September in 2022, according to Dow Jones Market Data. 

    The U.S. stock market has been startled by surging bond yields following the Fed’s policy meeting in September, after being jolted by the rise in Treasury rates in August.

    “The price to pay for a resilient economy is higher yields,” said Steven Wieting, chief economist and chief investment strategist at Citi Global Wealth, in an interview. “We’re probably near the peak in yields.”

    The yield on the 10-year Treasury note
    BX:TMUBMUSD10Y
    ended September at 4.572%, after rising just days earlier to its highest level since October 2007, according to Dow Jones Market Data. Yields and debt prices move opposite each other.

    But for Camporeale, it’s still too early to venture out to the back end of the U.S. Treasury market’s yield curve to add duration to bondholdings. That’s because the yield curve is not yet “re-steepened” and he views the U.S. economy as currently on course for a soft landing with rates staying higher for longer.

    “If you avoid recession, why should you have a lower yield as you go out in time?” said Camporeale. “You should be compensated for having more yield as you go out in time if you avoid recession, not less.”

    The 2-year Treasury rate
    BX:TMUBMUSD02Y
    finished September at 5.046%, continuing to yield more than 10-year Treasury notes.

    The yield curve has been inverted for a while, with short-term Treasurys offering higher rates than longer-term ones. The situation is being monitored by investors because historically such inversion has preceded a recession. 

    “If we were nervous about growth we would be buying the 10-year part of the curve or the 30-year part of the curve,” said Camporeale. “But we are not doing that right now.”

    As for asset allocation, he said he’s now neutral stocks and overweight U.S. high-yield credit, particularly bonds with shorter durations of one to three years. 

    Camporeale sees junk bonds as a “nice” trade as he is not expecting a recession in the next 12 months and they are providing “enticing” yields versus the U.S. equity market, which probably has most of its returns in “versus what we think you get through the rest of the year.”

    The S&P 500 index was up 11.7% this year through September, FactSet data show. 

    While watching for any signs of deterioration in the labor market, Camporeale said he now anticipates the earliest the Fed may cut rates is in the second half of next year. To his thinking, the recent move higher in 10-year Treasury yields was appropriate “in a world where maybe the yield curve has to re-steepen.” 

    ‘Pain trade’

    Bond prices in the U.S. broadly dropped in September along with the stocks. 

    The iShares Core U.S. Aggregate Bond ETF
    AGG
    was down 2.6% last month on a total return basis, bringing its total loss for the third quarter to 3.2%, according to FactSet data. That was the fund’s worst quarterly performance since the third quarter of 2022.

    The ETF, which tracks an index of investment-grade bonds in the U.S. such as Treasurys and corporate debt, has lost 1% on a total return basis so far this year through September, FactSet data show. Meanwhile, the iShares 20+ Year Treasury Bond ETF
    TLT
    has seen a total loss of 9% over the same period.

    “Few investors want to call the top for peak rates,” said George Catrambone, head of fixed income at DWS, in a phone interview. Some bond investors had started to extend into long-term Treasurys in July. “That’s been the pain trade, I think, ever since then,” said Catrambone.

    As for the equity market, the speed of the move up in 10-year Treasury yields hurt stocks, with the rate climbing “well beyond what many assumed would be the upper end,” according to Liz Ann Sonders, chief investment strategist at Charles Schwab. 

    With higher rates pressuring equity valuations, “clearly what’s going to matter is third-quarter-earnings season, once that kicks in” during October, she said by phone. Company “earnings are going to have to start to do some more heavy lifting.”

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