Continued from Part 4: Mortgage Rates Jump
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
Last week was all about the jobs report, which showed unemployment dropping to 7.3% and also the labor force participation rate dropping to 63.2% – the lowest since 1978. The week started off with the ISM Manufacturing Report, which was stronger than expected at 55.7. Construction spending rose .6% as well, which was good news for the homebuilders. Initial Jobless Claims came in at 323k, the second-lowest reading since the Great Recession began, while productivity came in at a good reading of 2.3%. Finally, on Friday, we saw that non-farm payrolls rose 169k in the month of August, which was disappointing. The 10 year bond yield had a 3 handle ahead of the report, but rallied on the disappointing print.
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. The consensus seems to be that 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.
Implications for homebuilders
Homebuilders, like Lennar (LEN), KB Home (KBH), and Standard Pacific (SPF), are more sensitive to general economic strength. The strong ISM report showed the manufacturing sector is doing well, which was good to see. But the disappointing jobs report demonstrated that the nascent economic strength still has yet to filter through to jobs.
Continue to Part 6: The upcoming FOMC meeting
- Part 1 - Exploring performance and yields for Mortgage REITs
- Part 2 - Lack of volatility implications for NLY, AGNC
- Part 3 - Ginnie Mae TBA trading
- Part 4 - Mortgage Rates Jump
- Part 5 - Impact of economic strength on REITs
- Part 6 - The upcoming FOMC meeting
- Part 7 - Recommendation: how to play increasing interest rates for Mortgage REITs
© 2013 Market Realist, Inc.