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The 10-year bond is the basis for all mortgage pricing
Long-term interest rates are priced off the benchmark long-term bond, which is the ten-year Treasury. These days, the ten-year bond reacts to economic data through the Federal Reserve’s asset purchase program, also known as quantitative easing (QE). As a general rule, economic data that shows weakness is bond bullish; however, data that shows strength is not necessarily bond bearish.
The week in review
Last week, the 10-year bond yield increased by 40 basis points, one of the biggest sell-offs in recent memory. The FOMC meeting was the highlight of the week.
On Monday, the National Association of Homebuilders Market sentiment index had its first net positive reading since the housing boom. On Tuesday, the consumer price index showed inflation remained in check. Housing starts disappointed while building permits came in line with expectations.
On Wednesday, we got the FOMC rate decision, and the action was all in Ben Bernanke’s press conference. The Fed said that the default path was to end quantitative easing by mid-2014 and to begin scaling back purchases starting as early as this Fall.
Finally, on Thursday, initial jobless claims came in at 354,000, a little bit higher than expected. Existing home sales came in at an annual pace of 5.18 million, a big jump.
Implications for mortgage REITs
Mortgage REITs, like Annaly and American Capital, are driven by interest rates. Unsurprisingly, the Mortgage REIT ETF (MORT) fell 6.2% last week. The mortgage REITs have been crushed as the 10-year bond has sold off. For REITs, it’s all about the Fed’s exit of QE. They are trying to de-leverage in a very hostile bond market. Going forward, the REITs are really just looking for some stability. If rates stabilize, they may find their footing.
Implications for home builders
Home builders, like Lennar (LEN), KB Homes (KBH), and Standard Pacific (SPF), are more sensitive to general economic strength. The NAHB home builder sentiment index showed the first net positive (over 50%) reading since the bubble years. The change in interest rates was a negative for builders. While purchase activity is less interest-rate sensitive than the refinance market, it still is sensitive to increases in interest rates. The housing starts number was disappointing, although it may have been affected by weather.
Builders will be looking for evidence that the increase in interest rates is beginning to affect the economy overall. If we get a slow down, new home sales will almost certainly suffer.
© 2013 Market Realist, Inc.