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Bonds Rally on July FOMC Statement

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Highlights of the July 2016 FOMC statement

On July 27, 2016, the Fed ended its FOMC (Federal Open Market Committee) meeting without hiking the federal funds rate. The decision was unanimous with only Esther George dissenting. The Fed set up markets for a rate hike in the April FOMC minutes. Then, it backed off after the weak jobs report in May. While the language in the statement was largely upbeat about the economy, the lack of inflation and fears about weak corporate spending signaled that a September rate hike wasn’t imminent.

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Bonds rallied on the decision. The ten-year bond yield—which you can trade through the iShares 20+ Year Treasury Bond ETF (TLT)—fell from 1.6% to 1.5%. The two-year yield fell from 74 basis points to 72 basis points. Stocks rallied on the statement, although a late-day sell-off took the indices right back to where they were before the release.

Six FOMC members don’t see more rate hikes this year

While Fed Chair Janet Yellen always points out that all of the FOMC meetings are “live” meetings, in that they’re always prepared to act, the Market was handicapping a low chance of a rate hike. Given that the July meeting was an “off” meeting – in other words, a meeting where there is no press conference or forecasts were provided, the chance of a hike was low to begin with. In the Fed’s “dot plot,” which you can see above, the participants lowered their forecast for the federal funds rate at the end of the year. Six members aren’t expecting more rate hikes this year.

Implications for mortgage REITs

For agency mortgage REITs—including Annaly Capital (NLY), Two Harbors (TWO), American Capital Agency (AGNC), and MFA Financial (MFA)—the Fed’s hawkish statements regarding the economy aren’t necessarily good news. Higher interest rates won’t be good news for their repo financing. The bigger question will be how a rate hike will impact the long end of the curve. During the last three tightening cycles, the yield curve flattened and even inverted once. This would imply lower net interest margins for mortgage REITs and banks. Investors who are interested in trading the REIT sector should look at the Vanguard REIT ETF (VNQ).

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