The fixed-income markets suggest that the Federal Reserve may have backed down, despite longer-term securities experiencing a smaller rate decrease than the 2-year Treasury rates. See the huge change in rates for the 2 Year Treasury above. To me, it means the market believes the FED is about to blink and stop increasing rates.
Longer-term rates have not dropped as much, but this is logical as they look at the bigger trend. However, it may follow like the 10YR that is dropping fast. My mortgage guys have told me they are looking at the 10YR for rate direction. Does this mean mortgage rates may go down? See the chart below.
While this may seem positive for the economy, Chairman Powell stated there would be no rate cuts this year in his base case scenario. Admitting to future rate cuts could lock them into the forward curve and ease credit conditions, but it may not be a wise move.
The Risks and Benefits of Falling Interest Rates
The Federal Reserve’s plan involves creating a recession to push the economy towards lower inflation, which requires careful management. The free market could handle this better than a government-appointed official.
The falling interest rates may lead to a better scenario than higher rates, but deficits surge in every recession, leading to a bigger national debt financed at a higher rate. Investors may still find bargains in the market, but the base case scenario may differ from Chairman Powell’s or the bond market’s views.
The current year-over-year metrics may report a decrease in inflation, but shelter inflation from a year ago may still affect official inflation numbers.
Finding Opportunities in the Market
The market prices have been roughly flat since June 2022, but a few things have increased dramatically due to supply chain disruptions. Total returns can be maximized by including trading strategies that regularly trade positions in mortgage REIT common shares and BDCs. Investing in preferred shares and equity REITs could also be beneficial.
Investors can compare their performance against four ETFs that provide exposure to the sectors: MORT, PFF, VNQ, and KBWY. The sector has many opportunities, but investors must be cautious of the risks and avoid reaching for yield blindly. Common shares require more vigilance in protecting the principal by regularly monitoring prices and updating estimates for book value and price targets.
Chimera Investment Corporation and Ellington Financial are worth considering for investors who believe in the recovery of the housing market and a low default rate.
Alexandria Real Estate as a Long-Term Pick
Alexandria Real Estate is a great REIT trading below its normal range and could be an excellent long-term pick due to its decision to focus on long-term fixed-rate debts, leading to a favorable cost of debt.
Conclusion
In conclusion, the fixed-income markets’ response suggests that the Federal Reserve may have backed down. However, the Chairman’s comments that there will be no rate cuts this year in his base case scenario indicate that the Federal Reserve is cautious about making any drastic moves.
The falling interest rates could lead to a better scenario than higher rates, but it may come with its own set of risks. Investors can still find bargains in the market, and using trading strategies and investing in preferred shares and equity REITs could maximize total returns. Investors must be vigilant and cautious of the risks and avoid blindly reaching for yield.
