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).
Bond yields move to the upside again
After closing the previous week at 151 basis points, bond yields—as tracked by the iShares 20+ Year Treasury Bond ETF (TLT)—rose by 7 basis points to 158 last week. Bond yields initially fell on the dovish FOMC minutes, but rose due to stronger-than-expected economic data and a global bond sell-off.
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. The next thing to watch is when the Fed starts to allow its quantitative easing portfolio to roll off.
In the next part of this series, we’ll look at mortgage rates and discuss how they fell along with bond yields.