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Bond Yields Fell Last Week on the FOMC and Bank of Japan

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Basis for long-term interest rates

Ten-year bond yields influence everything from mortgage rates to corporate debt. Now they’re the benchmark for long-term US interest rates. Some might remember when the 30-year bond was the benchmark, but that changed in the 1990s. When investors want to know what’s going on in the bond market, they want to know where the ten-year bond is trading.

It’s important to note that short-term rates are still important, particularly LIBOR, as it’s the base rate for most short-term rates. Rate information is relevant to REITs like American Capital Agency (AGNC), Annaly Capital Management (NLY), Redwood Trust (RWT), and MFA Financial (MFA).

Investors can trade the REIT sector through the iShares Mortgage Real Estate Capped ETF (REM) or the whole financial sector through the S&P SPDR Financial ETF (XLF).

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Bond yields fall on the FOMC

After closing out the prior week at 2.1%, bond yields, as tracked by the iShares 20+ Year Treasury Bond ETF (TLT), fell 13 basis points last week to close at 1.9%. The Bank of Japan instituted negative interest rates, which pushed bond yields down globally as well.

Problems in the high yield market can spill over into the Treasury market as investors move their assets to safe havens like Treasury bonds. High yield funds are facing outflows, and leveraged buyouts are getting put on hold or scrapped. The Dodd-Frank Act decimated trading desks and market-making activity, leaving the market crowded with sellers and very few buyers. While this effect could hit the value of some structured products, it shouldn’t affect most REITs in vanilla mortgage-backed securities.

The mortgage REIT sector has been relatively underleveraged since the “taper tantrum” of 2013. The biggest change in the sector has been the move to swap interest rate risk for credit risk. Mortgage REITs have dry powder—undrawn capital—if they want to build up their balance sheets again.

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