Independent Banker - January 2025 - 33

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portfolio managers may reasonably
question whether this rate cycle
will look like those of the past. The
strategy implications could change
considerably if this cycle plays out
diff erently. Should this come to pass,
revisiting prior cycle steeps seems
entirely plausible and there is a wellworn
path regarding the appropriate
portfolio strategy steps to take:
extend duration, reduce premium
exposure and add various forms of
call protection.
What if...
However, the strategy implications
could change considerably if this cycle
plays out diff erently. Three options
are on the table if we accept the
premise that the next yield curve shift
is a steepening move:
 Bull steepener (downwards bias
where the short-term rates decline
more than long-term ones)
 Bear steepener (upwards bias where
the long-term rates rise more than
the short-term ones)
 Mixed steepener (short-term
rates decline while longer-term
rates increase)
Previous cycles have exhibited
bull-steepener behavior, so even
if the cumulative decline in policy
rates is somewhat lower this cycle,
the appropriate response is fairly
similar. Look to bonds carrying
deep discounts, which are typically
Portfolio managers may reasonably question
whether this rate cycle will look like those of the
past. The strategy implications could change
considerably if this cycle plays out differently.
agencies or mortgage-backed
securities (MBS) and collateralized
mortgage obligations featuring
coupons and/or gross weighted
average coupons (WACs) considerably
below current market levels. Another
option is instruments featuring
strong forms of call protection, such
as agency bullets, various forms
of agency CMBS, municipals and
corporates. Avoid higher-coupon
agency callables, higher-WAC MBS,
and fl oaters due to refi nanceability
and/or declining yields.
A bear steepener is arguably the
most challenging scenario of the
three, as few investments truly
benefi t from rising long-term rates.
The best-performing instruments
are the ones that get hurt the least.
Premiums are good here, as lower
prepay and call activity widens out the
window for premium amortization.
Reinvestment of cash fl ows is also
important, so short fi nals and/or
high levels of principal cash fl ow
perform well; hybrid adjustable-rate
mortgages combine these features in a
unique way.
The best investments in a mixed
steepener depend on the magnitude
of the move in each direction, but
tend to favor bullet-like investments
whose maturities fall around the
fulcrum point on the yield curve.
Prepayments and/or calls on shorter,
higher-yielding investments today can
be reinvested further out the curve as
cash fl ows come in.
As with any portfolio strategy,
you must consider the structure and
performance of existing holdings
alongside prospective additions or
repositioning strategies. However,
after several years of portfolio strategy
that felt very one-dimensional due to
both uniform challenges across the
industry and operating environments
that created a narrow solution set
to those challenges, 2025 seems
poised to make portfolio strategy fun
again given a wider array of balance
sheet dynamics and possible interest
rate scenarios.
Economic update webcast in January
ICBA Securities and its exclusive broker Stifel kick off their 2025
webcast calendar with the quarterly Economic Insight Live on
Jan. 30 at 1 p.m. Eastern. Stifel's chief economist, Lindsey Piegza,
will present. Up to one hour of CPE is off ered. For more information
and to register, contact your Stifel rep.
Michael Benedict
(benedictm@stifel.com) is a
managing director, fixed income
strategies, at Stifel, ICBA Securities'
exclusively endorsed broker.
independentbanker.org // 33
http://www.independentbanker.org
Independent Banker - January 2025

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