There’s a pretty broad consensus that spreads on asset-backeds, which widened substantially over the summer, have room to narrow, particularly now that market participants have returned from their holidays, resulting in better liquidity.
The Federal Reserve’s decision this week to put off raising rates for a little longer is also positive.
But participants on a trader’s panel at IMN’s ABS East conference were generally skeptical that spreads will recover all of the ground that they lost amid concerns about China’s economy, commodity prices and the selloff in U.S. equities.
“Based on conversations with clients over summer, it’s possible to tighten from here,” Antonio Blasetti, ABS trader at Brean Capital, said at IMN’s ABS East conference. “But there are some impediments, in particular a lot of supply from now to Thanksgiving.”
Then there is market volatility, and the effects of TRACE, which may be positive or negative, depending on the asset class.
He added, “I definitely think the supply will be absorbed, particularly with a lower interest rate environment in the fourth quarter.”
Will Zak, a director at Barclays, said that, “on a fundamental basis, we are definitely closer to the top, if not through, the spread cycle. I expect to see tiering especially in weaker subprime.”
Still, Zak sees upside for a number of asset classes.
“One of the cheapest sectors is FFELP, the non-downgrade bonds in the one to three years duration bucket are extremely cheap,” Zak said. “These bonds have no credit risk, there is no principal at risk… it’s mostly a legal maturity issue.”
He added that even “plain-vanilla stuff” like autos, have some room to recover.
Tom Oh, senior vice president, ABS trading at Lloyds Bank, agrees that FFELP bonds, which sold off heavily in June and July after Fitch Ratings and Moody’s Investors Serivce put some $37 billion under review for a potential downgrade, are a “compelling buy.”
“Over the summer, our clients were holding off cash,” said Oh. “A lot of cash is going to come [back] on board, especially in the fall.”
Dan Schaeffer, executive director at Mizuho cautioned that “liquidity is a premium, and FFELP doesn’t have much right now.” Nevertheless, he agrees that the bonds that are deeply discounted “look interesting.”
Schaeffer has a more bearish view than other panelists across all asset classes; he thinks there are plenty of reasons that spreads on all kinds of triple-A rated asset-backeds - even credit cards – could widen beyond 100 basis points.