Critical input for the housing market
Mortgage rates are the lifeblood of the housing market. The Fed’s plan to help the housing market started when it pushed rates lower to allow people to refinance. The Fed hoped that lowering mortgage rates would also support home prices.
Quantitative easing was a key part of that effort. The Fed is reluctant to sell its MBS (mortgage-backed securities) holdings. It doesn’t want to raise mortgage rates too much.
Mortgage rates rise
Lately, mortgage rates and bond yields have shown a weak correlation. Treasury yields have fallen over the past month, while mortgage rates have been steady. Last week, the ten-year bond yield fell 12 basis points to 1.5%. Mortgage rates rose by 3 basis points to 3.6%. Investors interested in making directional bets on interest rates can look at the iShares 20+ Year Treasury Bond ETF (TLT).
Impact on mortgage REITs
At this point, mortgage bankers such as Nationstar Mortgage Holdings (NSM) and Wells Fargo (WFC) are hoping that 2016 is the year Millennials start buying homes. Mortgage bankers are dreading the inevitable decline in refinancing activity as rates rise, but they’re hoping the purchase business continues to improve. With the ten-year bond yield trading below 1.5%, we should see an increase in prepayment speeds.
The increase in prepayment speeds should be bad news for mortgage REITs such as Annaly Capital Management (NLY) and American Capital Agency (AGNC). They’re highly leveraged agency REITs with a lot of prepayment exposure. Non-agency REITs such as Redwood Trust (RWT) tend to swap interest rate risk for credit risk.
Investors interested in trading in the mortgage REIT sector through an ETF can look at the iShares Mortgage Real Estate Capped ETF (REM).
In the next part of this series, we’ll discuss the movement of Fannie Mae TBA (to-be-announced) securities last week.