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Mortgage Rates Fall as Bonds Rally

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Mortgage rates are a critical input to the housing market

Mortgage rates are the lifeblood of the housing market, and the Fed’s plan to help housing began with pushing rates lower in order to allow people to refinance. The central bank also hoped that lowering mortgage rates would support home prices.

The government’s focus is now to draw first-time homebuyers into the market. The government has been announcing measures to increase credit availability for the first-time homebuyer. We’ll see if the changes actually affect buying patterns.

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Mortgage rates fall with bond yields

Mortgage rates fell as bonds rallied on the weak jobs report. Even though rates continue to fall, mortgage rates dropped only reluctantly at this level. During the week of the FOMC meeting, where bond yields fell 18 basis points, mortgage rates only fell six basis points. Last week, bond yields decreased 13 basis points and mortgage rates decreased ten basis points to 3.74%.

That said, we’ve seen tremendous volatility in the ten-year over the past month, so mortgage rates have tended to “fade” these moves. This is another example of mortgage rates “fading” the ten-year.

Effect on mortgage REITs

Mortgage bankers like Nationstar (NSM) are in a position to perhaps wring out a good 2015 after a dismal 2014. Certainly the MBA mortgage banking indices indicate an improvement.

It looks like we have prepayment burnout at rates around these levels. It isn’t until rates hit the 3.8% level that prepays start kicking in. REITs that focus on agency MBS, like Annaly Capital (NLY) and American Capital Agency (AGNC) will have to deal with the combination of lower rates and increased prepayment speeds if mortgage rates fall back towards the lows.

Investors interested in trading in the mortgage REIT sector via an ETF should look at the iShares Mortgage Real Estate Fund (REM). Investors who are interested in making directional bets on interest rates should look at the iShares 20-year bond fund (TLT).

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