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Mortgage Rates Tick up Despite Bond Market Rally

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Mortgage rates are a critical input for the housing market

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

Quantitative easing was a key part of that effort, and the Fed is reluctant to sell its MBS (mortgage-backed securities) holdings for fear of raising mortgage rates too much.

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Mortgage rates ignore the bond rally on Friday

Mortgage rates have tended to fade big moves in the bond market lately. When rates fall well below 1.9% on the ten-year bond, mortgage rates fall, although only slightly. Similarly, when rates rise to 2.3%, mortgage rates tend to rise only slightly.

Last week, interest rates fell on the weak jobs report. The ten-year bond yield fell from 2.16% to 1.99%. Surprisingly, mortgage rates rose 5 basis points to 3.88%.

A general rule is that mortgage rates are somewhat less volatile than bond yields. When we see big outsized moves in bond markets, mortgage rates tend to lag behind the move. Traders refer to this phenomenon as “fading” the market. This phenomenon was apparent last week in particular.

Keep in mind that any contagion would generally be bullish for mortgage-backed securities that are guaranteed by the government, and this would push down mortgage rates.

Investors interested in making directional bets on interest rates can look at the iShares 20+ Year Treasury Bond ETF (TLT).

Effect on mortgage REITs

Mortgage bankers such as Nationstar Mortgage Holdings (NSM) and Wells Fargo (WFC) are having a decent 2015 after a dismal 2014. MBA (Mortgage Bankers Association) indices suggest an improvement; however, we’re nowhere near what could be considered normal. Fannie Mae is easing credit overlays, making these loans more accessible and cheaper, which should help boost credit, especially at the low end of the credit spectrum.

If mortgage rates continue to fall, you should start seeing the rate of prepayments accelerate. Lately, it wasn’t until rates hit 3.8% that prepays started kicking in. REITs such as Annaly Capital (NLY) and American Capital Agency (AGNC), which focus on agency mortgage-backed securities will have to deal with the combination of lower rates and increased rates of prepayment if mortgage rates fall back toward their lows.

Investors interested in trading in the mortgage REIT sector through an ETF can look at the iShares Mortgage Real Estate Capped ETF (REM).

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