The timing of the Fed’s third round of quantitative easing is among the top discussed topics today. While the exit has consequences for the general economy, it will have a much direct impact on the US financial sector, particularly the mortgage REITs sector. Under QE3, the Fed is buying mortgage backed securities at a record pace with the aim of bringing down mortgage rates. Mortgage REITs hold mortgage backed securities in their asset portfolios and earn asset yields on the securities held. The yields on MBS are related to the prevailing mortgage rates. Therefore, lower mortgage rates mean lower yields for mREITs.
Looking at the healthy expectations, cracks between the officials of the central banks have widened. According to the minutes of the latest meeting of the FOMC, several members of the committee are of the opinion that if the labor markets continue to improve, the quantitative easing has to slow down later in the year and stop by the end of the year.
According to Reuters, Dallas Fed President Richard Fisher, who has always voiced his concerns on the efficiency of the easing said, the US housing markets are showing signs of speculations, meaning they don’t need further stimulus. These comments came in hours after another Fed official termed a halt in easing as premature.
The release of the latest minutes of the meeting had the effect of depressing bond prices as they revealed extensive discussions and disagreements regarding the exit of $85 billion Treasury and mortgage bond buying each month.
A potential hindrance in the exit of this easing is the budget. Some of the members of the committee were of the view that the Fed should wait until it is certain how Congress plans to approach the coming budget. The officials at the Fed are concerned that if Congress tightens the fiscal policy, it will hurt economic growth. Therefore, the easing might prolong.
Sector That Underperformed
The mortgage REIT sector suffered a lot due to the easing over the last few quarters. Since the launch of QE3 in September last year, Annaly Capital Management, Inc. (NYSE:NLY), American Capital Agency Corp. (NASDAQ:AGNC), ARMOUR Residential REIT, Inc. (NYSE:ARR) and CYS Investments Inc (NYSE:CYS) reported 60 bps, 26 bps, 64 bps and 63 bps declines in their respective net interest rate spreads. Annaly Capital Management, Inc. (NYSE:NLY), ARMOUR Residential REIT, Inc. (NYSE:ARR) and CYS Investments Inc (NYSE:CYS) Investments were forced to cut dividends due this contraction in the spreads.
However, the situation has already started to reverse as mortgage rates increase and the spreads widen. Since the beginning of the year, the 30-year mortgage rate climbed 20 bps, while the 15-year average mortgage rate climbed 10 bps. Besides, the weekly surveys conducted by Mortgage Bankers Association reveal a drop in refinance activity, which will cause further benefit to mortgage REITs.
Conclusion
While members of the FOMC committee are increasing pressure to bring a halt to the Fed’s third round of easing, citing various reasons, I believe such an exit is not in sight until some clarity is reached regarding how Congress approaches the fiscal policy in the coming budget. However, when the easing is brought to an end, mortgage REITs like American Capital Agency Corp. (NASDAQ:AGNC), ARMOUR Residential REIT, Inc. (NYSE:ARR), Annaly Capital Management, Inc. (NYSE:NLY)and CYS Investments Inc (NYSE:CYS) will fly north, defying gravity. Therefore, you should keep an eye on the easing exit decision.
Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
