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).
Bonds rallied slightly last week after a disappointing jobs report on the prior Friday. Last week was relatively data light, and the best report —an initial jobless claim print below 300 thousand—was due to a computer glitch. That number will undoubtedly be revised upward next week. Retail sales disappointed and several sell-side firms took down their estimates of Q3 GDP to the mid 1% range. The retail sales numbers represent the extremely important back-to-school shopping season, which doesn’t bode well for the retailers heading into the make-or-break holiday shopping season. If consumption doesn’t get going, the economy will stay stuck in first gear, no matter how good housing gets.
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 consensus seems to be that last Friday’s jobs report wasn’t good enough or bad enough to change the Fed’s perception of the economy and its timing for ending QE. However, the withdrawal of Larry Summers as a potential Fed Chairman does change the calculus a bit on the end of quantitative easing.
Implications for homebuilders
Homebuilders, like Lennar (LEN), KB Home (KBH), and Standard Pacific (SPF), are more sensitive to general economic strength. The disappointing jobs report showed that the budding economic strength has yet to filter through to jobs. The retail sales number was a disappointment as well, and the University of Michigan consumer confidence number was not what the builders want to see.
- Part 1 - Analysis of breaking news: Larry Summers withdraws name from consideration
- Part 2 - Fannie Mae TBAs rally as Fed debates end of quantitative easing
- Part 3 - Ginnie Mae TBAs rally before the Fed meeting
- Part 4 - Mortgage rates fall as originators become more competitive
- Part 5 - Week in review: A sub–300 thousand initial jobless claims report?
- Part 6 - Week in preview: Why the Fed will be in the spotlight
- Part 7 - Analysis: With Summers out, implications for mortgage REITs
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