The ten-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 (positive). However, data that shows strength isn’t necessarily bond bearish (negative).
The week in review
On Monday, the Chicago Fed National Activity Index showed economic activity was approaching historical trends. Existing Home Sales came in weaker than expected, but still above the 5 million mark. On Tuesday, the Federal Housing Finance Agency reported that home prices rose 0.7% month-over-month and 7.3% year-over-year. On Wednesday, we saw mortgage applications stabilizing, while new home sales came in better than expected. (This bullish new home sales number stood in stark contrast to some of the homebuilder earnings, which noted that higher rates are starting to be felt.) On Thursday, we had initial jobless claims and a strong durable goods number. Finally, on Friday, the University of Michigan Consumer Confidence number hit a six-year high.
Implications for mortgage REITs
Mortgage REITs, like Annaly (NLY) and American Capital (AGNC), are driven by interest rates. The mortgage REITs have been crushed as the ten-year bond has sold off, but they’ve been trying to form a bottom here. For REITs, it’s all about the Fed’s exit of QE. Bernanke gave mortgage REITs a bit of a gift in the Humphrey Hawkins testimony—once the Fed ends asset purchases, it doesn’t intend to sell its holdings into the market. Instead, it will let them mature and will re-invest maturing securities back into the MBS (mortgage-backed securities) market. For REITs who were fearing a Fed-driven sell-off of MBS, this news was particularly welcome. Hatteras (HTS) and Capstead (CMO) announced earnings last week, and Hatteras’ numbers showed that you aren’t necessarily safe hanging out in adjustable-rate mortgage securities in an increasing interest rate environment, especially if you have longer duration.
Implications for homebuilders
Homebuilders, like Lennar (LEN), KB Home (KBH), and Standard Pacific (SPF), are more sensitive to general economic strength. As we saw from the earnings announcement, the bullish new home sales number was a bit of a head fake, and builders sold off on earnings in general. The most important numbers for builders last week were Pulte’s (PHM) decline in orders and the University of Michigan Confidence Number.
© 2013 Market Realist, Inc.
But if I knew how to manage my portfolio safer and smarter than most hedge fund managers, I could realistically grow my wealth.