The 10-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 (QE). As a general rule, economic data that shows weakness is bond bullish; however, data that shows strength is not necessarily bond bearish.
The week in review
On Monday, we had the Empire State Manufacturing Survey which came in better than expected. Retail sales disappointed, which has some market participants worrying if higher rates are crimping consumption. On Tuesday, the Consumer Price Index showed inflation was well-behaved at the consumer level. Industrial Production and Capacity Utilization showed continued activity in the manufacturing sector, and the National Association of Home Builders sentiment index hit a post-bubble high. Given the strong sentiment index, the drop in housing starts was a bit of a head-scratcher. Blame it on volatile multi-fam sector. Ben Bernanke gave his Humphrey-Hawkins testimony, which was relatively dovish. Finally on Thursday, Philly Fed was a little better than expected, while the Index of Leading Economic Indicators was flat
Implications for mortgage REITs
Mortgage REITs, like Annaly (NLY) and American Capital (AGNC), are driven by interest rates. The Mortgage REIT ETF (MORT) recovered 4% after dropping 8% the week before. The mortgage REITs have been crushed as the 10-year bond has sold off. For REITs, it’s all about the Fed’s exit of QE. Mortgage REITs were given a bit of a gift in the Humphrey Hawkins testimony – once the Fed ends asset purchases, it does not intend to sell its holdings into the market. Instead, it will let them mature, and will re-invest maturing securites back into the MBS market. For REITs who were fearing a Fed-driven sell-off of MBS, this news was particularly welcome.
Implications for home builders
Home builders, like Lennar (LEN), KB Home (KBH), and Standard Pacific (SPF), are more sensitive to general economic strength. The industrial production and capacity utilization numbers bode well for hiring going forward. The NAHB Homebuilder Sentiment Index showed homebuilders as positive has they were during the bubble years. While the low housing starts number was a disappointment, it is more relevant to multi-fam builders, not single family construction. The two homebuilders with November fiscal years – Lennar and KB Home – reported strong second quarter earnings. We will hear from the rest shortly.
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