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Mortgage Rates Ignore the Rally in the Bond Market

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Mortgage rates are a critical input to the housing market

Mortgage rates are the lifeblood of the housing market. The Fed’s plan to help housing began when it pushed rates lower to allow people to refinance. The central bank also hoped that lowering mortgage rates would support home prices.

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

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Mortgage rates aren’t buying the latest bond market rally

Mortgage rates have tended to “fade” the big moves in the bond market lately. When rates dip well below 1.9% on the ten-year, mortgage rates move lower only very reluctantly. When rates increase to 2.3%, mortgage rates have tended to move up only grudgingly. Last week, the ten-year bond yield decreased nine basis points, and mortgage rates were unchanged at 3.9%.

As a general rule, mortgage rates are somewhat stabler than bond yields. When we see big outsized moves in the bond markets, mortgage rates tend to lag the move.

Effect on mortgage REITs

Mortgage bankers like Nationstar Mortgage Holdings (NSM) are in a position to perhaps wring out a good 2015 after a dismal 2014. Certainly, the MBA (Mortgage Bankers Association) indices suggest an improvement.

If rates continue to fall, you should start seeing prepayments accelerate. Lately, it’s not until rates hit the 3.8% level that prepays start kicking in. REITs that focus on agency mortgage-backed securities, including MFA Financial (MFA) and American Capital Agency (AGNC), will have to deal with the combination of lower rates and increased prepayment speeds if mortgage rates fall back toward the lows.

Investors interested in trading in the mortgage REIT sector through an ETF should look at the iShares Mortgage Real Estate Capped ETF (REM). Investors interested in making directional bets on interest rates should look at the iShares 20+ Year Treasury Bond ETF (TLT).

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