Week in review: Small bond rally as we await government shutdown

Brent Nyitray, CFA, MBA

Realist real estate roundup, September 23–27 (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).

Bonds rally as the market digests the FOMC decision and contemplates a government shutdown

Last week we didn’t have much in the way of market-moving data. The Chicago Fed National Activity Index showed manufacturing is improving, and the home price indices showed good growth. Initial jobless claims fell to 305,000. The bond market was stuck between digesting the inaction out of the Fed and the potential government shutdown. A shutdown would be a negative for the economy, which would almost certainly take an October change in QE off the table. These two events would be bond bullish.

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. The ten-year bond also rocketed up, as you can see from the intra-day yield chart above.

Implications for homebuilders

Homebuilders, like Lennar (LEN), KB Home (KBH), and Standard Pacific (SPF), are more sensitive to general economic strength. Lennar and KB Home reported second quarter earnings last week. Generally, the numbers were good, but both companies noted a decrease in traffic as rates have risen. The Chicago Fed National Activity Index and the Markit PMI numbers were good. For the builders, the most important numbers were the increases in the home price indices and the increase in household net worth. These numbers are tied together, and increasing home equity is exactly what the builders need to see. Increasing net worth is a must to drive building higher.

Continue to Part 6

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