The 10-year Treasury yield has risen sharply this year and was recently above 5.3%. That's not just a 52-week high, but it's also the highest level since 2002. Several factors have driven up bond yields, including elevated inflation, a massive federal deficit, and the debt-fueled AI infrastructure spending boom.
Rising government bond rates weigh on the value of other income-focused investments. That's why AGNC Investment (AGNC -2.98%) has hit a 52-week low while the 10-year is at its peak. Shares of the mortgage REIT are down nearly 30% from their 52-week high, pushing its yield above 16.5%.
What's going on in the Treasury market?
The 10-year Treasury has risen from less than 4% before the U.S. and Israel launched attacks on Iran earlier this year to its highest level in nearly a quarter-century. The war has caused one of the biggest energy supply shocks on record due to shipping constraints through the Strait of Hormuz. Higher energy prices and shipping costs fueled a resurgence in inflation. The Consumer Price Index (CPI) rose 0.4% in August, putting the 12-month increase at 3.4%, above the Federal Reserve's 2% target. That drove the Fed to raise rates for the first time in three years last month, with more hikes likely.
This has a trickle-down effect on fixed-income markets. In AGNC Investment's second-quarter earnings release, CEO Peter Federico noted that "the investment environment in the second quarter continued to be challenging" due to concerns about the war's impact on the economy. The CEO noted that, "These concerns caused Treasury yields to increase, the yield curve to flatten, and the market's monetary policy expectations to pivot from rate cuts to rate hikes." On a positive note, Federico stated, "Although mortgage spreads have declined from recent peak levels, they remain elevated by historical standards."
AGNC AGNC Investment Corp.
How does this impact AGNC?
AGNC's entire business is investing in Agency MBS on a leveraged basis. It makes money on the spread between what its investments earn and the cost of financing its portfolio. As Federico noted, those spreads narrowed in the second quarter, though they're still relatively high. Spreads have likely tightened further over the past quarter due to the surge in the 10-year, a key benchmark for mortgages and other debt.
The key for AGNC is the returns it can generate on its investment portfolio. Federico pointed out on the second-quarter call that the return on equity it's getting when it leverages investments within its 7.0-7.5x target range is 15% to 17%. He noted at the time that this "aligns really well with the economics of our dividend." As long as its returns remain above its cost of capital (operating costs plus dividend payments), its dividend will remain aligned. That makes the REIT's upcoming quarterly conference call later this month a crucial source of new information as Federico will likely run through the current economics of its portfolio, giving a hint at the dividend's sustainability.
Rates play a meaningful role in this REIT's returns
Changes in interest rates have a significant impact on AGNC investment. If they keep rising, that would put additional pressure on its stock price, driving its current yield even higher. It would also further compress its spread income. It's a risk investors need to watch closely as it could eventually put the dividend at risk.
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