For Mortgage REITs, Taper Is Now Baked In

For the battered mortgage REIT sector, it's beginning to look as if investors' biggest fear was fear itself.

Ever since whispers began earlier this year that the Federal Reserve's open-ended quantitative easing program might be soon eased out of existence, mREITs -- particularly agency trusts like Annaly Capital (NYSE: NLY  ) , American Capital Agency (NASDAQ: AGNC  ) , and Armour Residential (NYSE: ARR  )  -- began to sputter. This year alone, Annaly has fallen by 28%, American Capital Agency has dropped 31%, and Armour has plummeted by 42%.

While it is obvious that the very idea of an end to QE3 sent investors into paroxysms of anxiety, I believe it was the fear of the unknown that damaged the mREIT sector the most. Now that the inevitability of the taper is accepted, I think mREITs will recover. In fact, following a slew of commentary by Federal Reserve members on Monday, I think the rally has already begun.

The taper is definitely on the table
The Federal Reserve Bank of Chicago got the ball rolling Monday morning, releasing its economic outlook for 2014. Based upon the consensus of those attending the Economic Outlook Symposium, the Chicago Fed painted a sunnier economic picture for the coming year. Real GDP is expected to increase from 2% this year to 2.7% in 2014, while unemployment is predicted to drop to 6.8% by the end of the year.

With such a rosy outlook on tap, a winding down of QE3 looks more certain than ever for the very near future. In a speech yesterday, St. Louis Fed President James Bullard supported such a view, noting that recent employment gains have increased the likelihood of a reduction in the Fed's bond-buying program. Bullard, who has been a steadfast supporter of QE3, noted that a "small taper" would get his vote, and that moderation would prevail. Tapering could be put on hold, he said, if inflation targets were not met.

Meanwhile, the head of the Dallas Federal Reserve Bank  noted that while it is high time to map out a plan to end the easy money program, making its plans clear to the market should be tops on the Fed's to-do list. Richmond Fed President Jeffrey Lacker also weighed in , warning that a slowing of bond and security purchases would spook markets into expecting an early rise in short-term interest rates, as well.

Agency REITs are simmering down
The agency mREIT sector has been climbing since Monday, probably because the Fed's path is less obscure. The comments by Bullard and Dallas Fed chief Richard Fisher seem to indicate that a slow taper will be discussed at the December 17 to 18 Federal Open Market Committee meeting, and that implementation will be swift. The concern expressed by Lacker doesn't really make much sense, as the Fed has been clear that short-term rates will stay low until at least 2015 .

Now that much of the uncertainty regarding the taper has been relieved, mortgage REITs will rally -- although, there may be pockets of panic during the FOMC meeting, as well as when the taper actually starts. Right now, Annaly, American Capital Agency, and Armour are each up more than 2%, as the bulk of the Nervous Nellies have sold off, and bargain hunters pile in.

Annaly's heavy trading on Tuesday is a sign that investors have come to the realization that, despite a lower dividend, a yield of more than 14% remains one of the best investing deals around.

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