The yield curve spread provides a leading indicator for the stock price of $NLY, $AGNC, $MTGE and other mortgage REITs. The mortgage REIT sector has been pummeled this year, off as much as 30% while the DJIA and S&P 500 are up 18% and 23% respectively.
Keeping a close eye on the yield curve can provide a leading indicator to the price action in mortgage REITs. As you can see in the charts below, the 2s10s yield curve spread flattened in March and April and then met significant resistance against its 200 day moving average in early May. The 2s10s yield curve moved sharply steeper in May moving above its 50 day moving average and to the upper Bollinger Band. The rout in mortgage REITs was officially underway.
2s10s Yield Curve Spread vs Mortgage REIT Equity Performance
Source: CurveTrades and Google Finance
What does the yield curve tell us about what to expect next? October's rally in $NLY, $AGNC and $MTGE followed 2s10s moving below its 50 day moving average and to the lower Bollinger Band. Yesterday, 2s10s reversed and closed just above the lower Bollinger Band. If 2s10s steepens from the current 222 basis point level and heads toward 230 bps or higher, expect the mortgage REIT sector to trade off.
An interesting long/short trade is long mortgage REITs and long the yield curve steepener. We will discuss alternative approaches to determine the hedge ratio in Friday's blog post.
RIDE THE CURVE!
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