Week in review: Why bonds rallied with the Fed’s decision
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 (or 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).
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Bonds rally as the Fed makes no change to asset purchases
Bonds had two bullish pieces of news last week. First, Larry Summers withdrew his name from consideration for the next Federal Reserve Chairman. Second, the Fed decided to maintain its asset purchase program (otherwise known as quantitative easing). We also had some decent industrial numbers earlier, which showed that the manufacturing sector was continuing to expand—though modestly. Housing starts and building permits disappointed, as higher rates began to have an impact. That said, the single-family starts were still increasing. The drop was in multifamily starts.
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 (quantitative easing). The fact that it got a break from tapering sent the mortgage REIT ETF (MORT) screaming higher. The ten-year bond also rocketed up, as you can see from the intra-day yield chart above. On Friday, St. Louis Federal Reserve Chairman James Bullard characterized the decision as a close call and laid the groundwork for a small reduction at the October meeting. Most market participants believed the change would come at the December or September meetings, not the October meeting.
Implications for homebuilders
Homebuilders, like Lennar (LEN), KB Home (KBH), and Standard Pacific (SPF), are more sensitive to general economic strength. The industrial numbers were decent, and this should bode well for manufacturing jobs going forward. Capacity utilization is still low, but it’s heading in the right direction. Building permits and housing starts were disappointing, but the drop seems to be in multi-family construction, not single-family construction. This includes most of the major homebuilders.