Stocks and bonds rally as the market sees the Fed is on its side

Market Realist

Realist Real Estate Roundup, October 14–18 (Part 5 of 7)

(Continued from Part 4)

The ten-year bond is the basis for all mortgage pricing

Long-term interest rates are priced off the benchmark long-term bond, which is the ten-year Treasury. These days, the ten-year bond reacts to economic data through the Federal Reserve’s asset purchase program, also known as quantitative easing (or QE). As a general rule, economic data that shows weakness is bond bullish (positive). However, data that shows strength isn’t necessarily bond bearish (negative).

The attached chart isn’t of the ten-year, however—it’s the chart of the one-month Treasury. The one-month T-bill is usually not followed all that closely, but you can see that it spiked on the possibility of delayed payment. Once we had a deal, it went back to its yield of around 0%.

Bonds rally after the government strikes a deal to stay open

Government shutdowns are invariably treated like once-in-a-century calamities. But in reality, we’ve had periods during the late ’70s and most of the ’80s where they happened almost every year. Markets tend to have a little more historical perspective than media types who have to hype a story, which explains why the market basically yawned at the whole affair.

Stocks and bonds rallied on the news of a deal. The rally was not due to relief that the government wasn’t going to default—the market couldn’t have cared less if the government were open, and it realized the government had the wherewithal to make principal and interest payments so default wasn’t a real possibility. The markets rallied because it knew the Fed would be on its side for a while longer. Any near-term tapering is off the table.

Implications for mortgage REITs

Mortgage REITs, like Annaly (NLY) and American Capital (AGNC), are driven by interest rates. The mortgage REITs have been crushed as the ten-year bond has sold off, but they’ve been trying to form a bottom here. For REITs, it’s all about the Fed’s exit of QE (quantitative easing). The fact that it got a break from tapering sent the mortgage REIT ETF (MORT) screaming higher. Recently, St. Louis Federal Reserve Chairman James Bullard characterized the decision as a close call and laid the groundwork for a small reduction at the October meeting. Most market participants believed the change would come at the December or September meetings, not the October meeting. The shutdown and debt ceiling almost certainly make an October tapering a low probability.

Implications for homebuilders

Homebuilders, like Lennar (LEN), KB Home (KBH), and Standard Pacific (SPF), are more sensitive to general economic strength. We did get the NFIB Small Business Optimism Survey, along with the IBD/TIPP Economic Optimism, both of which disappointed. The University of Michigan Consumer Sentiment numbers were weaker as well. With the government shutdown last week, we’re not getting a lot of economic data.

Continue to Part 6

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