Should You Buy AGNC Investment Ahead of Federal Reserve Interest Rate Cuts?

With inflation mostly back under control, the Federal Reserve's attention has shifted toward the labor market, where the unemployment rate has inched higher in the past few months as job creation numbers slow.

Last month, the unemployment rate triggered the " Sahm rule ," which says when the three-month average of the unemployment rate rises half a percentage point above its low over the prior 12 months, the country is headed toward a recession. With that backdrop, the Federal Reserve has signaled that it is ready to cut interest rates for the first time since 2020.

AGNC Investment (NASDAQ: AGNC) is one stock burdened by the higher-interest-rate environment. The mortgage real estate investment trust (mREIT) pays an appealing 14% dividend yield, but the stock price has plummeted 32% since early 2022 when the Fed first began its interest rate hiking cycle. With the CME Group 's FedWatch tool projecting up to 1.75 percentage points worth of rate cuts over the next year, is now the time to scoop up AGNC Investment stock?

Rising interest rates have weighed on the mortgage REIT

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

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

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MBS don't typically have high payouts. Because AGNC invests in relatively safe agency-backed MBS, it uses leverage to boost its returns. To do so, AGNC uses repurchase agreements (repo) and other arrangements to leverage its portfolio. These debt instruments generally mature in a year or less, and short-term interest rates and volatility in debt markets ultimately determine how much interest AGNC pays on these investments.

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

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

Rising rates also impacted the book value of AGNC's investments because of something called "spread risk." This happens when the spread between the yield on its book value and the yield on its interest rate hedges widens, resulting in a declining book value. From 2021 to 2023, AGNC's net book value per share has fallen 44%.

AGNC Net Interest Income (TTM) data by YCharts

Is AGNC stock a buy?

The change in monetary policy the Fed signaled 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 couple of years, and its average asset yield sits at 4.69% at the end of the second quarter, up from 2.31% at the end of 2021. Falling short-term rates would give AGNC a larger net interest spread between its longer-term investments and shorter-term borrowings.

Many market participants believe the Federal Reserve will lower its benchmark rate as soon as September, which could help steepen the yield curve. A rate-cutting cycle should boost AGNC's net interest spread and the book value of its portfolio. That could be a strong tailwind for the stock over the next year or two.

However, it isn't out of the question that inflation and interest rates remain elevated over the next decade. Geopolitical tensions, rising fiscal deficits, and de-globalization of the world economy could potentially result in higher inflation and interest rates over the next decade, posing a longer-term interest rate risk for those investing in AGNC today.

A buy of AGNC stock is likely to be affected, at least in part, by how you feel about the broader economy going forward.

Courtney Carlsen has no position in any of the stocks mentioned. The Motley Fool recommends CME Group. The Motley Fool has a disclosure policy .