Interest Rates Tic Higher While Panic is Averted
By: Tim McPartland,
Well as we expected the announcement of a 1/4% Fed funds rate increase turned out to be mostly a non event, although over the course of a day and a half the 10 year treasury has moved around in a 10 basis point range caused by the Fed’s more aggressive statements relative to 2017. Yellen’s statement that they were looking at 3-4 rate increases in 2017 is almost laughable. At this time last year she said the same thing–and what happened? 1 rate increase. To us it is not whether there will be a certain number of rate increases, but that Yellen believes that she has credibility to the investing public when she has been terribly wrong for years.
So with the news behind us for now we look at the reaction. Perpetuals and long duration baby bonds continue to move lower on average by 10 cents since the announcement. Additionally, REITs and mREITs in particular, moved lower by 1-3% as investors fretted about the higher cost of refinancing in the future. mREITs, in particular, will experience almost immediate higher costs when borrowing as they finance mostly with reverse repo borrowing (they borrow very short term with an agreement to buy back the collateral in 1-120 days), while lending on a long term basis. This means that they are dependent on the “spread” between short term rates and long term rates for their margin. If short rates rise and long rates stay level, fall or move higher by less than short rates rise the spread gets compressed. It is impossible to truly predict what this spread will be in the future, but it is safe to say that margins will probably be under pressure, but until they compress more than the current spreads mREITs look to be attractive to the more adventuresome investor. Additionally the mREITs have some of the highest yielding preferreds outstanding and it is likely that these issues will outperform most perpetual preferreds as junkier issues have proven time and again to have less downside movement compared to investment grade issues. In spite of the pressure on the common shares of mREITs the preferreds of Annally (NLY-A, NLY-C, NLY-D), Anworth Mortgage (ANH-A, ANH-C), Chimera (CIM-A), CYS (CYS-A, CYS-B) as well as many others with current yields of 8-9% are attractive. If rates continue to rise these will drift lower, but at least an investor will be receiving substantial compensation while they are being held. If you are sensitive to net asset value movements in your portfolio you should simply skip perpetual preferreds and long duration baby bonds and stick with those issues with shorter duration–here.
Personally we have learned to be very patient with our investing and we favor short durations because we believe rates will in fact be moving higher in 2017 and better bargains will be revealed (no guarantee that we are right–Yellen has no crystal ball and neither do we). We are happy being compensated at 6-7% for our patience–we also sleep very well at night. While we will stick to short/medium duration fixed income securities we are on the hunt for some MLPs and REITs and this weekend will post some moves we are will be making to try to improve performance in the Blended Income Portfolio which has been performing inadequately lately.