Opportunities on the Longer End of the
Treasury Yield Curve
By David Farris
Fixed Rate Agency MBS, longer-term municipal bonds and tax-exempt PC’s currently offer attractive yields and spreads to treasury on the longer end of the TSY curve. Risk tolerance, interest rate bias, unrealized bond losses and lack of liquidity have kept many banks on the sidelines for the last several months. However, given where the market is now, we believe it is time to consider layering in some longer duration investments into the bond portfolio.
The first thing to consider is the current level of the market relative to where it has been historically. Exhibit 1 shows the 10yr TSY. The current yield of 4.11% is close to the recent highs of 4.34% on 8/21/2023 and 4.24% on 10/24/2022. The last time the 10yr TSY was this high was 4.27% on 6/16/2008, just prior to the final descent into the great recession.
The historical ten-year Regression on the 10yr TSY in Exhibit 2 illustrates the same story. The current rate of 4.21% (as of 8/28) is higher than 2 standard deviations away from the mean, which is 2.41%.
Exhibit 3 shows some of the investment opportunities available on the longer end of the curve. The first four shown are 20yr and 30yr fixed rate MBS. These examples have yields ranging from 5.40% to 5.90% with spreads to TSY well over 100 bps. Spread to treasuries on fixed rate MBS are as wide as they have been since COVID and in 2008/2009 (Exhibit 4).
The bottom section of Exhibit 3 shows tax-exempt options. The municipal shown is a MO GO BQ with a 2043 maturity, a 5.00% coupon and 7 years to the call. This has a tax-equivalent yield of 5.86% (4.10% after-tax) with a spread to treasuries of 166 bps. This bond is rated AA+. There are many similar opportunities for value in AA- and higher ratings with maturities beginning in 2035 and longer.
The last option shown in Exhibit 3 is a Freddie Mac tax-exempt PC. The collateral is multi-family housing for low-income renters where the rent payments are subsidized by the government, making them federally tax-exempt and essentially tax-free Freddie K’s. These are less liquid than regular 30yr MBS but are Freddie Mac guaranteed and are accepted collateral at the FHLB. They are currently cheap to the other longer alternatives with tax-equivalent yields 40 to 60 bps higher.
The treasury yield curve remains inverted as the market continues to anticipate the end of the Fed tightening cycle and warns of a possible recession on the horizon. At the time this article was penned, the inversion between the 2yr and 10yr TSY rates (4.91% vs. 4.11%) is 80 bps. Additionally, the 3m TSY yield remains inverted to the 10yr TSY yield by 139 bps with the 3m TSY at 5.50%, making the decision to extend duration even more difficult when short rates are this high. However, the value in the longer end of the market providing spreads to TSY of well over 100 bps and yields in excess of Fed Funds/EBA of 5.35% is making the decision to extend more attractive.
Please contact your Country Club Bank Sales Representative for further information on the securities discussed here and to find the best investments that fit your risk tolerance and interest rate bias.
This information is intended for institutional investors only. The material provided in this document/presentation is for informational purposes only and is intended solely for private use. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.
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