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
The bond market rebounded after hitting new lows after last Friday’s better than expected jobs report. The report came on July 5, which was an exceptionally thin day as many traders took a 4 day weekend. On Monday, rates began rebounding. On Monday, the Federal Reserve reported that consumer credit increased by 19.6 billion, the biggest jump in a year. On Tuesday, we saw that small business is still struggling in the NFIB Small Business Report, but the Labor Department reported 3.8 million job openings for May. On Wednesday, the Federal Reserve released the minutes from their June FOMC meeting, while import prices were flat. On Thursday, we had initial jobless claims and the Consumer Comfort Index. On Friday, we saw that pricing pressures at the wholesale level were subdued and that consumer confidence remains elevated, at least in reference to the post-crisis period.
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. The FOMC statement didn’t give much in the way of comfort, but Ben Bernanke’s comments were interpreted as dovish. The REITs are trying to de-leverage in a very hostile bond market. Going forward, the REITs are really just looking for some stability. If rates stabilize, they may find their footing. The week before, rates stabilized and the REITs actually rallied.
Implications for home builders
Home builders, like Lennar (LEN), KB Home (KBH), and Standard Pacific (SPF), are more sensitive to general economic strength. Friday’s consumer confidence report was positive for them. That said, watch the producer price index, as input costs might be increasing for them. 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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