Agency commercial mortgage-backed securities (CMBS) spreads rallied significantly over the month of November due to a positive pickup in investor sentiment. Cooling inflation coupled with a slightly weaker labor market has investors building confidence that the Fed has reached the end of their hiking cycle—volatility in the overall market has decreased over the course of the month. Spreads have caught a further tailwind from projections of the supply on bonds in the market remaining on the low end. Broker-dealers are accumulating balance-sheet positions while also filling strong end-account orders. Positive investor sentiment is projected to remain through year-end, barring any major macro shift.

The November rally in MBS spreads and U.S. Treasury rates highlights a shift in investor sentiment that occurred between the September and November Federal Open Market Committee (FOMC) decisions. The September FOMC meeting was somewhat of a shock to the market. The market fully expected that the Fed would pause the hiking campaign but did not expect the Fed’s projections for future rates moving forward. The FOMC released their updated Summary of Economic Projections and updated Dot Plot at the September meeting, which showed that 12 of 19 Fed officials see one more hike as necessary in 2023, while seven officials see a hold. Berkadia’s full coverage of the September FOMC meeting can be found here. The notion that the Fed would be holding rates “higher for longer,” coupled with the Dot Plot hinting that the Fed may hike rates again, drove uncertainty in the overall market. Treasury rates sold off, with the 10-year U.S. Treasury (UST) rate peaking at 5%. Agency MBS spreads widened following the FOMC meeting through the month of October after failing to recoup the typical widening at quarter-end.

Spreads continued to widen until the November 1 FOMC meeting: The FOMC held rates at the 5.25%–5.50% level and noted in the statement that tighter financial and credit conditions for households and businesses continue to weigh on the economy. The addition of “financial conditions” to the Fed’s statement was a surprise; previously the statement had only highlighted “credit conditions.” “Credit” might refer to banks making it harder to get loans, while “financial” suggests more of a market situation: Bloomberg Economics estimates that a persistent increase in long-term yields would substitute for 25–50 basis points of hikes, but failure for them to be persistent would necessitate another hike or two. Berkadia’s full coverage of the November FOMC meeting can be found here.

The addition of “financial conditions” reversed the market’s negative sentiment on the Fed’s Dot Plot. The market is no longer pricing in any additional rate hikes and is now awaiting cuts. MBS spreads were positively impacted by a fall in bond-market volatility, portrayed by the Merrill Lynch Option Volatility Estimate (MOVE) index in the chart below. Investment-grade credit default swaps, which tend to trade in tandem with Agency CMBS spreads, also tightened significantly over the month of November. The market seems to be reading the tea leaves and calling current levels the Fed’s terminal rate of this hiking cycle, while macroeconomic conditions continue to provide positive general sentiment for the market in the short term.

Agency CMBS spreads are being positively impacted by macroeconomic conditions as well as micro market projections. As noted in Berkadia’s previous spread commentary, found here, Agency CMBS spreads are highly affected by supply and demand. Market demand for bonds was restored in the month of November due to the positive sentiment shift, but the supply of bonds did not follow suit. Fannie Mae Delegated Underwriting and Services (FNMA DUS) production in October and November was over 50% lower in 2023 than it was in 2022. Current market sentiment is that supply will remain on the lower end in the short term, with strong demand and low supply continuing to provide positive momentum for spreads.