Summary of US Rates Outlook 2026 Fixed Income Industry Overview - The report focuses on the US rates market and the economic backdrop as it enters 2026, characterized by stalled inflation progress, uneven growth, and signs of labor market weakness [2][7][8]. Key Points and Arguments Economic Conditions - Economic growth in the US is more resilient than expected, potentially boosted by the One Big Beautiful Bill Act (OBBBA) and AI-driven capital expenditures [7]. - Consumer spending is mixed; higher-income consumers are driving spending while lower-income households face affordability challenges [7]. - Labor market indicators show a modest increase in unemployment and slowing nonfarm payroll growth, but the labor market has not collapsed [7][22]. Inflation and Interest Rates - Disinflation towards the Federal Open Market Committee's (FOMC) 2% inflation target has stalled, with both headline and core inflation measures remaining around 3% [7][29]. - The report forecasts 10-year Treasury yields at 4.30% by the end of 2026, higher than the Bloomberg consensus of 4.06% [2][8]. - The Fed is expected to maintain a neutral duration conviction, with potential for yields to rise due to dual-sided risks to policy [6][8]. Federal Reserve Dynamics - The conclusion of Jerome Powell's term as Fed Chair is a focal point, with potential personnel changes at the FOMC that could influence policy views [4][51]. - The Fed is likely to commence net asset purchases, particularly in T-bills, starting in Q1 2026 to mitigate funding pressures [4][65]. Treasury Supply and Demand - The Treasury's strategy of holding coupon issuance sizes steady is expected to continue through H1 2026, with maturity extension anticipated due to persistent deficit pressures [5][71]. - The report highlights that long-dated Treasuries may underperform swaps in the coming months due to supply and demand dynamics [5][89]. Yield Curve Scenarios - Four policy paths are outlined to frame potential rates outcomes: resilient growth with sticky inflation, inflation resurgence, moderate slowdown, and severe slowdown [3][35]. - The baseline scenario anticipates bear steepening of the yield curve, while an inflation resurgence could push 10-year yields to test 5% [10][39]. Risks and Market Positioning - The balance of risks skews towards further curve steepening, with optimal positioning suggested in the belly of the curve where structural risks are lower [3][46]. - The report cautions against long positions in the front-end due to negative carry and labor market concerns limiting hawkish repricing [9][46]. Additional Important Content - The report discusses the potential impact of the IEEPA tariff decision on fiscal deficits and the Treasury's reliance on T-bills for funding [81][84]. - It notes that the relative value of T-bills may decline as policy rates decrease, potentially shifting demand towards higher-returning risk assets [80][81]. - The report emphasizes the importance of monitoring repo market pressures and their implications for Treasury supply absorption [100]. This comprehensive analysis provides insights into the US rates outlook for 2026, highlighting key economic indicators, Federal Reserve dynamics, and potential investment strategies within the Treasury market.

Financial Data and Key Metrics Changes - The economic return for the quarter was negative 4.8%, consisting of a $0.34 dividend per common share and a $0.76 decline in book value per common share [7] - The debt to equity ratio decreased from 7.1x at the end of March to 6.5x at the end of June, indicating a more defensive posture due to elevated near-term uncertainty [7] - As of July 18, 2025, the estimated book value per common share is between $7.99 and $8.31, reflecting a slight recovery in performance [8][25] Business Line Data and Key Metrics Changes - The Agency RMBS portfolio decreased by 15% quarter over quarter as the company managed risk amid trade policy uncertainty [18] - The allocation to Agency CMBS increased from 15% at the end of Q1 to just over 17% as of June 30, 2025, due to the decline in the Agency RMBS portfolio [20] Market Data and Key Metrics Changes - Interest rates declined across the front end of the Treasury yield curve during Q2, while long-term rates increased, reflecting expectations for accommodative policy from the FOMC [6][11] - The two-year Treasury yield declined by 16 basis points, while the thirty-year yield increased by 20 basis points, leading to the steepest two-thirty spread in nearly 3.5 years [11][12] Company Strategy and Development Direction - The company maintains a cautious near-term outlook but is optimistic about the long-term demand for Agency mortgages due to attractive valuations and stabilization in interest rate volatility [8][25] - The focus remains on specified pools with predictable prepayment behavior, particularly in lower loan balance collateral [18] Management's Comments on Operating Environment and Future Outlook - Management noted that financial conditions were volatile in Q2 but ended modestly accommodative, with expectations for two rate cuts by year-end and additional cuts in 2026 [5][25] - The company believes that further easing of monetary policy will lead to a steeper yield curve and a decline in interest rate volatility, supporting long-term demand for agency mortgages [25] Other Important Information - The company’s liquidity position is strong, providing a cushion for potential market stress while allowing for capital deployment as the investment environment improves [25] - The financing market for Agency CMBS remains robust, with no concerns about deterioration during a widening event [62] Q&A Session Summary Question: How does the company view the relative risk versus reward for high coupon RMBS? - The company believes that spreads reflect the risk accurately and has reduced exposure to higher coupon RMBS due to their sensitivity to interest rate volatility [29][30] Question: What is the company's comfort level on leverage? - The company is comfortable with its current leverage, which is lower than in Q1, and does not feel the need to increase leverage to meet return goals [33][34] Question: What is the outlook for swap spreads and the mix of hedges? - The company anticipates that swap spreads will widen, which would be beneficial, and is currently at maximum allocation to interest rate swaps [37][38] Question: What are the views on core earnings and dividends? - The company expects ROEs to remain attractive, supporting the current dividend without significant changes in the near term [41][45] Question: How does the company feel about CMBS spreads when the Fed cuts rates? - The company is comfortable with the financing market for Agency CMBS and expects spreads to tighten as the Fed cuts rates [60][62]

Financial Data and Key Metrics Changes - For Q1, the company earned $0.18 per share compared to $0.07 in Q4 [5] - Book value at March 31 was $7.94 per share compared to $8.09 at December 31 [5] - Total return for the quarter was 2.6% unannualized compared to 0.6% for Q4 [5] - Liquidity at March 31 was 52.2% compared to 52.9% at December 31 [7] Business Line Data and Key Metrics Changes - The average portfolio was just under $6 billion compared to $5.3 billion in Q4 [6] - The leverage ratio at March 31 was 7.8 compared to 7.3 at December 31 [6] - Prepayment speeds were 7.8% in Q1 compared to 10.5% for Q4 [6] Market Data and Key Metrics Changes - The market moved to price in three or more Fed cuts by the end of the year [11] - Swap spreads moved meaningfully negative late in the quarter and into April [14] - The spread of the current coupon mortgage to the ten-year has widened significantly [16] Company Strategy and Development Direction - The company raised capital during the quarter and deployed it into higher coupon, shorter duration assets [24] - The strategy includes using longer duration hedges to mitigate exposure to declining swap spreads [24] - The company is focused on maintaining liquidity and is prepared to raise capital if necessary [76] Management's Comments on Operating Environment and Future Outlook - The management expressed uncertainty due to market volatility driven by tariffs and inflation [55] - The expectation is for slower growth and potential Fed eases, which could lead to a steeper yield curve [58] - The company is positioned with a skew towards higher coupon, shorter duration assets, which should work well in the current environment [59] Other Important Information - The company declared and paid dividends of $0.36 per share for each quarter [5] - The management acknowledged a mistake in the initial earnings release regarding the breakdown of earnings per share [9] Q&A Session Summary Question: What is the duration gap at the end of the quarter and to date? - The duration gap is very narrow, with a DV01 basis of $13, remaining about the same as of now [62][63] Question: Where do you see gross ROE sitting today? - The gross ROE is estimated to be around 20%, with high volatility in swaps [73] Question: How are you looking at dividend issuance and buybacks? - The company is cautious about buybacks due to stock trading close to book value and may consider raising capital for liquidity [76][78] Question: Will the 2025 dividend be 100% taxable income? - It is uncertain at this point, but the taxable income has been right on top of the distribution year to date [91][93] Question: Thoughts on the Rocket Mortgage and Nationstar deal? - The deal may increase prepayment speeds and impact the convexity of the mortgage universe negatively [99][100]