Stocks are higher as Tehran agrees to send someone to talks in Pakistan. Bonds and MBS are flat.
Fed nominee Kevin Warsh will have a confirmation hearing in the Senate today. This is his chance to demonstrate central bank independence to the markets and reassure investors that he won’t be a rubber stamp for Trump. Warsh got the nomination partially because he was willing to buck the conventional wisdom at the Fed that rates should be coming down. Since then, circumstances have changed and the situation in Iran makes rate cuts almost impossible.
Warsh will probably take a wider view of his role and want to maintain central bank independence and avoid repeating the mistakes of the 1970s.
Retail sales rose 1.7% in March, according to the Census Bureau. This is a 4.0% increase from a year ago. Since these numbers are not adjusted for inflation, on a real basis sales rose modestly. Given the turmoil in the Gulf, the Street was looking for a much more modest increase. Even if you strip out gasoline and motor vehicles, sales rose 4.2%. February’s numbers were revised up.
Mortgage REIT AGNC Investment reported earnings yesterday. AGNC Investment buys mortgage backed securities backed by the US Government and is therefore the buyer of the mortgages the industry originates. Earnings rose and the company maintained its dividend, but it was hit by wider MBS spreads driven by higher interest rate volatility. MBS spreads represent the increased yield investors demand to hold mortgages versus Treasuries. As spreads increase (or “widen”) mortgage rates rise relative to Treasuries. In other words, the 10 year yield might increase by 10 basis points and mortgage rates might increase by 12 basis points. Or conversely the 10 year yield could fall and mortgage rates do nothing. You can see what happened below: MBS spreads increased 14 basis points relative to Treasuries in Q1.
What causes mortgage rates to do that? Interest rate volatility. Mortgage backed securities behave differently than Treasuries because the borrower always has the option to refinance. When rates become more volatile the value of that refinance option increases which makes MBS less attractive to investors relative to Treasuries. Volatility is measured by the MOVE Index, which is sort of like the VIX for bonds:
I like to talk about mortgage REITs when they report because it gives people in the industry insight into why rates do what they do. Mortgage professionals are very in touch with how borrowers think, but often are in the dark about “the other side of the trade” i.e. the investors who buy our loans.
