The Fed's monthly purchases of U.S. Treasuries and mortgage-backed securities is coming to an end. Recent Fed minutes suggest that "QE infinity" could end as soon as October.
And for all the talk about an end to quantitative easing, the market doesn't seem to care. U.S. Treasury rates have been mostly stagnate.
The players that should have been most affected haven't been. Highly levered Annaly Capital Management (NLY +1.03%) and American Capital Agency (AGNC +1.31%) have been off to a great 2014.
What's happening?
Put simply, the Fed represents only a single source of demand for U.S. Treasuries and mortgage-backed securities. Recently, banks have stepped up their U.S. Treasury purchases to hold on balance sheet.
It seems silly to be buying U.S. Treasuries at a time when the consensus is that rates should be going up any minute now. But banks have access to "held-to-maturity" accounting. They don't have to take writedown losses on those accounts when they expect to be paid in full at maturity. And spreads between deposit rates (which are near-zero) and 10-year U.S. Treasuries are still quite high -- high enough to make a bank profitable.
So while the Fed ends its buying, higher rates on the margin are encouraging banks to take the easy way out by buying risk-free U.S. Treasuries and agency MBSes instead of making loans.
Not the fed, but banks
If the trend holds that banks refrain from lending and instead simply arbitrage short-term deposit rates and risk-free U.S. Treasury and agency securities, mortgage REITs should survive rate increases just fine.
All the cash in the banking system effectively serves as a tamper on a rising rate environment. Now more than ever, banks are pretty happy not to be lending. Borrowing at 0.05% and lending to the government at 2.5% is a "good enough" business model.
That's good for American Capital Agency and Annaly Capital, which need rates to increase slowly in order to escape a rising rate environment with minimal losses to their leveraged balance sheets. Bank participation in U.S. Treasury and MBS markets should help keep rates from an instantaneous jump, which is exactly the situation mREIT shareholders don't want to see.
And as long as this trend persists -- it has been going on since the financial crisis -- there's no reason to think that an end to quantitative easing should bring an immediate and substantial increase in long-term rates. That's good for Annaly, and American Capital Agency.
