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
Given that last week was a holiday week, movements might have been exaggerated as many people took vacations and left junior traders in charge on Friday. On Monday, we got the ISM Manufacturing Report which showed that manufacturing is back in expansionary territory. On Tuesday, the IBD / TIPP economic optimism index fell slightly. On Wed, we found that mortgage applications fell, but it was mainly refinance activity that fell. The ADP jobs report foreshadowed a good jobs report for Friday. The market closed early on Wed. On Friday, we had the jobs report, which showed that nearly 200,000 jobs were created in June, and the April and May totals were revised upward by 70,000. The unemployment rate held steady at 7.6%. As a result of Friday’s jobs report, the 10 year bond yield increased 24 basis points to 2.74% and the average 30 year mortgage increased by 25 basis points.
Implications for mortgage REITs
Mortgage REITs, like Annaly (NLY) and American Capital (AGNC), are driven by interest rates. Unsurprisingly, the Mortgage REIT ETF (MORT) fell 8% 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. The week before, rates stabilized and the REITs actually rallied.
Implications for home builders
Home builders, like Lennar (LEN), KB Home (KBH), and Standard Pacific (SPF), are more sensitive to general economic strength. Friday’s jobs report is more likely to be a positive than a negative for them. The two homebuilders with November fiscal years – Lennar and KB Home – reported strong second quarter earnings. We will hear from the rest shortly.
© 2013 Market Realist, Inc.