Should You Buy AGNC Investments Before Federal Reserve Interest Rate Cuts?

With inflation back under control, the Federal Reserve’s attention has turned to the labor market, where the unemployment rate has risen over the past several months as job creation numbers slow.

Last month, the unemployment rate triggered the “Sahm ​​rule,” which says that when the three-month average of the jobless rate rises half a percentage point above its 12-month low, the country is headed for a recession. In this context, the Federal Reserve has signaled that it is ready to cut interest rates for the first time since 2020.

AGNC Investments (AGNC 0.49%) it is a stock weighed down by the higher interest rate environment. The mortgage real estate investment trust (mREIT) pays an attractive dividend yield of 14%, but the share price has fallen 32% since the start of 2022, when the Fed began its rate hike cycle. With CME GroupWith his FedWatch tool projecting rate cuts of up to 1.75 percentage points next year, is now the time to pick up AGNC Investment stock?

Rising interest rates have hurt the mortgage REIT

Real estate companies rely on debt to finance and leverage their investments, and rising rates lead to rising debt, which has hit the sector hard.

AGNC invests in agency mortgage-backed securities (MBS), which are pools of residential mortgage loans grouped together and sold to investors. The company focuses primarily on mortgages backed by government-sponsored entities that guarantee principal and interest payments, such as Federal National Mortgage Association (Fannie Mae) and Federal Mortgage Loan Corporation (Freddie Mac).

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MBS do not typically have large payouts. Because AGNC invests in relatively safe, agency-backed MBS, it uses leverage to increase its returns. To do this, AGNC uses repurchase agreements (repos) and other arrangements to leverage its portfolio. These debt instruments generally mature in one year or less, and short-term interest rates and volatility in the debt markets ultimately determine how much interest AGNC pays on these investments.

AGNC profits from the difference between the interest income it earns on its MBS portfolio and the amount it pays in borrowing costs. Because it borrows short-term money and invests in long-term MBS, it is sensitive to changes in the yield curve (the relationship between interest rates and time to maturity).

This sensitivity has become particularly pronounced in recent years as the Fed has aggressively raised its benchmark interest rate. Last year, AGNC’s interest income rose 28% to $2 billion due to higher rates on its MBS portfolio. However, borrowing costs rose significantly and interest expenses rose from $625 million to $2.3 billion. As a result, the REIT had a net interest loss of $246 million, down from net interest income of $965 million in 2022 and $1.3 billion in the year before the rate hike cycle began.

Rising rates also hurt the book value of AGNC’s investments because of something called “spread risk.” This happens when the difference between the return on its book value and the return on its interest rate hedges widens, resulting in a decline in book value. From 2021 to 2023, AGNC’s net book value per share decreased by 44%.

AGNC Net Interest Income (TTM) data by YCharts

Is AGNC stock a buy?

The change in monetary policy signaled by the Fed should benefit AGNC. A steep yield curve, where short-term interest rates are low while long-term rates are higher, allows AGNC to borrow at a lower cost while investing in higher-yielding MBS.

The mREIT has been able to invest in higher-yielding mortgages over the past two years, and its average return on assets stood at 4.69% at the end of the second quarter, up from 2.31% at the end of the year 2021. Short term decrease. rates would give AGNC a larger net interest differential between its long-term investments and shorter-term borrowings.

Many market participants believe the Federal Reserve will cut its benchmark rate as soon as September, which could help flatten the yield curve. A rate cut cycle should boost AGNC’s net interest margin and the book value of its portfolio. This could be a strong tailwind for stocks over the next year or two.

However, it is not out of the question that inflation and interest rates will remain high over the next decade. Geopolitical tensions, rising fiscal deficits and the deglobalization of the world economy could result in higher inflation and interest rates over the next decade, presenting a longer-term risk for those investing in AGNC today.

A purchase of AGNC stock will likely be affected, at least in part, by how you feel about the economy in general.