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
After a tumultuous week with the FOMC meeting, things settled down and bonds rallied. On Monday, we had a couple of mixed reports from the Chicago Fed and the Dallas Fed. Tuesday was a huge data day, with durable goods orders, New Home Sales, Consumer Confidence, and the Case-Shiller index, which posted its biggest year-over-year gain ever. On Wednesday, we got the third and final revision of first quarter GDP, which was revised downward from 2.4% to 1.8%. Personal Income and Personal Spending showed the consumer is starting to wake up. On Thursday, the National Association of Realtors’ Pending Home Sales index showed that buyers have not been negatively affected by the hike in rates, at least not yet. Finally, on Friday, the University of Michigan Consumer Confidence index showed a gain.
Implications for mortgage REITs
Mortgage REITs, like Annaly (NLY) and American Capital (AGNC), are driven by interest rates. Unsurprisingly, the Mortgage REIT ETF (MORT) fell 6.2% the week of the FOMC meeting. 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. They 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. Last week, the bond market stabilized and the Mortgage ETF rallied.
Implications for home builders
Home builders, like Lennar (LEN), KB Home (KBH), and Standard Pacific (SPF), are more sensitive to general economic strength. Earnings reports from Lennar and KB Home last week showed that the increase in rates is actually driving business as buyers now feel a “sense of urgency” as both home prices and borrowing rates are on the rise. This bodes well for the rest of the home builder earnings reports which will be released next month.
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