If You Own Homebuilders, Here’s Why You Should Watch What The Bank Of Japan Does
It goes without saying that the primary reason for the current strength in
the housing market is the result of multi-decade low mortgage rates. And as many
investors know, there is a pretty strong correlation between the yield of
Treasury securities and mortgage rates. The reason for this strong relationship
is that individual mortgages are bundled together and then issued out as bonds
in the financial markets; and like most bonds, these issues, which are known as
mortgage-backed securities, are priced relative to the risk-free interest rates
paid on government debt (Treasuries). The rates on mortgage-backed securities
are most sensitive to those of the 10 year notes because most 30-year mortgages
are paid off in 10 years. Â
The Asia Factor
Most market participants are now aware that the primary catalyst for the
decline in Treasury yields, and mortgage rates, can be attributed to speculative
buying by investors who expect a lack of inflation and continued accommodative
monetary policy by the Fed. However, few people are aware that Asian central
banks, primarily the Bank of Japan, China and Malaysia have also been sizable
purchasers of US Treasuries, causing a more pronounced decline in interest
rates.
Many Asian economies are highly dependant on exports for their livelihood.
And in an effort to keep their goods competitively priced, the central banks in
these countries intervene in the currency markets (buying US dollars while
selling their country’s currency) when their currency strengthens, as is the
case with the Bank of Japan ; China’s central bank is more systematic with its
intervention, as it keeps its currency pegged to the dollar–that is, at a fixed
rate.
Weakness in the dollar is often the result of a trade deficit (more imports
than exports). When foreign goods and services are sold in the US the revenues
from these transactions needs to be repatriated back to the exporting country,
which means that US dollars are exchanged (sold) for foreign currency (bought).
This then pushes the value of the US dollar lower relative to the currency of
countries that have trade surpluses with the US–as is the case with China and
Japan.
Enter Treasuries
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Most of the US dollars that are purchased by these central banks go towards
purchasing the low-risk US Treasuries. Central Banks now own $750 billion worth
of US government securities, or roughly 20% of the existing market. Moreover,
the biggest holders are the Bank of Japan and the Bank of China. In fact, last
month the Bank of Japan purchased a record breaking $34 billion worth of
Treasuries. So as long as our Asian trading partners continue to intervene in
the foreign exchange markets to make their exports cheaper, demand for US
Treasuries will also continue, resulting in lower mortgage rates and a stronger
housing stocks, such as Centex
(
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PowerRating) and Hovnanian
(
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PowerRating) –than what
would normally be the case.Â
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