August job report not disappointing enough to change Fed direction
The ten-year bond has sold off dramatically since May 1
The ten-year bond has sold off dramatically since May 1, as the yield has increased from 1.67% to 2.63%. This has driven the average 30-year fixed-rate mortgage to 4.38%. The conventional wisdom for the move has been that the market is discounting an end to quantitative easing. The sell-off started on a better-than-expected jobs report and continued as companies announced generally good first quarter earnings. Economic data over the month has been mediocre—certainly nothing that would cause the Fed to change course. Then the market started getting hints that the Fed was considering ending quantitative easing, and Bernanke made it official in the June FOMC (Federal Open Market Committee) meeting. The default path is to start reducing quantitative easing this year and end it fully by mid-2014.
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Highlights of the report
The economy added 169,000 jobs in August—lower than the consensus forecast of 180,000. July was revised downward to 104,000 jobs from 162,000. The unemployment rate fell to 7.3% from 7.4%, largely due to a drop in the labor force participation rate to 62.3%—the lowest since 1978. Average hourly earnings increased 0.2% month-over-month and the average workweek rose by 0.1 hours to 34.5. Overall, the headline drop in the unemployment rate was encouraging, but the reason for the drop was not. After June’s torrid report, July and August were a bit of a disappointment. The report caused rates to drop, which was a breath of fresh air for the REIT sector.
Implications for mortgage REITs
The mortgage REIT sector has had a difficult time over the past three months. Rates have been increasing, as has volatility. We’ve seen large declines in book value per share as the sector struggles to de-leverage in a hostile environment. Even last week, we saw an extremely wide trading range for the ten-year bond yield—2.81% to 3.01%. This sort of volatility gives mortgage-backed security investors conniptions. From what we’ve seen out of American Capital Agency (AGNC), maybe the bulk of the deleveraging is done, at least in the TBA sector.
Since rates started increasing, American Capital Agency (AGNC) is down 30% and Annaly (NLY) is down 26%. The REITs that focus on adjustable-rate mortgages, like MFA Financial (MFA) and Hatteras (HTS), have fallen less but are still down double-digit percentages. Where has the port in the storm been? The servicers like Nationstar (NSM) and Ocwen (OCN). They hold mortgage servicing rights, which increase in value as interest rates rise. Unsurprisingly, their stocks have risen since rates started going up.