Capital Markets Update

Week of 2/16/26 - 2/23/26

A slowing economy means lower rates, right? Thanks to the partial government shutdown the week prior, last week’s economic calendar included both labor market and inflation updates. Nonfarm payrolls increased by 130k in January, and the unemployment rate declined to 4.28 percent. Despite negative revisions to the prior two months, the latest report suggests job growth may be stabilizing. On the inflation front, both headline and core inflation moderated in January, rising 0.2 percent and 0.3 percent, respectively. On an annual basis, core inflation declined to 2.5 percent, the lowest reading since March 2021, when it stood at 1.7 percent.

Firmer employment data and cooler inflation reduce the likelihood that the Fed will feel compelled to change the current stance of monetary policy next month. Other recent data points, including slowing wage growth and improving productivity, should help ease labor-cost-driven inflation pressures. Additionally, recent consumer softness appears concentrated in goods spending rather than signaling a broad-based economic pullback. Monetary policy is nearing a neutral stance, while still giving the Fed flexibility to respond if risks shift toward either side of its dual mandate. As a result, yields on the 5-year note and longer tenors to their lowest closing levels since early December while the 2-year yield settled at its lowest level since September 2022,

Recent equity volatility has not been severe enough to prompt Fed concern about tightening financial conditions, though some degree of “de-wealthing” could help cool demand given how concentrated consumption is among higher-income households. Still, December’s flat retail sales and persistently weak consumer confidence raise the risk that financial strain may be spreading beyond lower-income cohorts and beginning to show up in aggregate data, especially once nominal figures are adjusted for inflation, making upcoming personal spending data critical to assessing momentum.

As housing affordability deteriorates, lenders and builders are increasingly relying on tools such as down payment assistance, which now accounts for about 20 percent of FHA loans in Ginnie Mae II 30-year pools, up sharply from 7.5 percent at the start of 2025, while VA usage has climbed more modestly to 3.4 percent, both near multi-year highs. Although down-payment assistance (DPA) borrowers show only slightly lower FICO scores and similar DTIs compared with non DPA borrowers, they exhibit consistently higher severe delinquency and buyout rates, reflecting somewhat weaker long term performance trends. Importantly for investors, DPA exposure is heavily concentrated in higher coupon pools, where as much as 21 percent to 54 percent of certain 7.0 percent and 7.5 percent coupons consist of DPA loans, making coupon selection a key consideration for those seeking to target or avoid this borrower cohort.

This holiday-shortened week has a fairly busy economic calendar, including several shutdown-delayed releases. Following the President’s Day holiday yesterday, there’s the NY Fed manufacturing for February and the NAHB Housing Market Index (expected to rise marginally from the previous reading). Over the remainder of the week are durable goods for December, housing starts and building permits (for November and December), industrial production/capacity utilization (January), December’s advance economic indicators, the first read on Q4 GDP, new home sales, S&P Global February flash PMIs, and final February consumer sentiment. Tuesday starts with Agency MBS prices better than Friday’s close by .125-.250, the 2-year yielding 3.40, and the 10-year yielding 4.03 after closing last week at 4.06 percent given yet more government shutdown news impacting the U.S. economy.

Commentary by Rob Chrisman