uploads/// year bond yield LT

Why Did Bonds Rally on Brexit?

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Jun. 28 2016, Updated 9:09 a.m. ET

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 investors might remember when the 30-year bond was the benchmark. However, 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.

You should note that short-term rates are still important, particularly LIBOR. It’s the base rate for most short-term rates. Rate information is relevant to REITs such as 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 Financial Select Sector SPDR Fund (XLF).

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Bond yields continue to fall

After closing the prior week at 1.6%, bond yields, as tracked by the iShares 20+ Year Treasury Bond ETF (TLT), fell by 5 basis points to 1.6% last week. The Brexit vote caused a flight to safety. Overseas bonds rallied heavily, with the German 10-year Bund closing the week with a yield of -5 basis points. Japanese government bonds ended the week at -20 basis points. This sort of behavior in foreign bond markets invariably impacts US bond yields on relative value trade. Portfolio managers will swap government bonds that yield nothing with bonds that yield at least something.

Despite the overall bid for Treasuries, bond issuance has been relatively muted this year. Financial markets remain inhospitable for most big corporate deals. In fact, most of the bond issuance this year has been related to mergers. While carnage in the energy exploration and production space impacted bond issuance and some buy-side firms, it hasn’t really spread to markets and the economy as a whole.

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, or undrawn capital, if they want to build up their balance sheets again.

In the next part of this series, we’ll look at mortgage rates and how they fell along with bond yields.

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