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Bonds Rally on the Dovish July FOMC Minutes

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FOMC minutes from July 2016

When the Fed meets for its FOMC (Federal Open Market Committee) meeting, it usually puts out a press release that explains the highlights of the meeting. The Fed also gives a brief economic overview and sometimes hosts a press conference.

Analysts usually compare the current statement with the previous one. They note any changes in language. The FOMC meeting minutes are much more in-depth than the press release. They’re usually 10–20 pages long.

The minutes include graphs and a two-sided discussion about the issues at hand. They explain the current discussions and give some idea about how popular certain views are within the Fed.

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Bonds’ reaction to the minutes

As the above chart highlights, bonds have been rallying (yields falling) ever since the Fed hiked rates in December. A subsequent weakening in overseas economies and a moderation in US growth sent bond yields (TLT) lower despite a tightening bias at the Fed.

On August 17, 2016, the Fed released the minutes from the July FOMC meeting. The July meeting was long enough for markets to absorb the shock of the Brexit vote (which hung over the June meeting) and for markets to realize that no financial contagion was going to happen. The Fed noted that most of the reaction to the Brexit vote had been unwound during the intermeeting period.

Overall, bonds took the FOMC minutes to be relatively dovish. The economy is improving, but enough participants are concerned about a potential downturn that market participants discounted a September move. Bonds rallied modestly on the minutes—they fell by about 4 basis points to 153 basis points.

Mortgage REITs such as Annaly Capital Management (NLY), American Capital Agency (AGNC), MFA Financial (MFA), and Two Harbors Investment (TWO) are hoping that the Fed will maintain low rates for as long as possible. Increasing short-term rates will raise their cost of funds and could hurt the value of their mortgage-backed securities portfolios if long-term rates rise. However, MFA Financial should be in a better position—its book is comprised of adjustable-rate securities.

Investors who are interested in trading the mortgage REITs through an ETF can look at the iShares Mortgage Real Estate ETF (REM).

This series will take an in-depth look at the June 2016 FOMC minutes and the implications for investors.

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