The yield on 10-year Treasury notes bottomed in early August at 55 basis points and has since doubled to about 1.10% today. Nevertheless, mortgage rates continue to decline, with the effective rate on 30-year fixed-rate mortgages dipping below 2% for the first time ever earlier this month according to the Mortgage Bankers Association’s weekly survey. For now, the good times will continue, with little upside pressure on rates.
A cursory examination of Figure 1 confirms that over time mortgage rates follow Treasury yields. Looking more closely, though, reveals several periods where the two series have diverged, at least temporarily. In late 2012 and early 2013, Treasury yields started rising while mortgage rates remained at a then-record low before eventually following Treasury yields higher. More recently, Treasury yields started rising in late 2019 though mortgage rates continued their decline. While broader bond market movements force mortgage securities (and hence mortgage interest rates) to follow Treasury yields over time, departures lasting several months, including the current departure, are not rare.
Figure 2 highlights the spread between Treasury yields and mortgage rates, and the solid black line indicates the mean spread from 2011 through 2019. When COVID first hit, investors flocked to Treasuries in a flight to safety, causing the spread to spike. Viewed in this light, the sharp decline in mortgage rates over the past ten months represents them reclaiming their usual position vis-à-vis Treasury yields rather than anything peculiar specific to the mortgage market.
Finally, we cannot ignore the impact of the Federal Reserve on both Treasury and residential MBS markets. Soon after COVID struck, the Federal Reserve began purchasing $80 billion in Treasury securities and $40 billion in MBS on a monthly basis and is likely to continue doing so for the foreseeable future. According to SIFMA, there is about $9.6 trillion in agency MBS outstanding, while the national debt has soared to $28 trillion with nearly $22 trillion publicly held. As a share of debt outstanding, the Federal Reserve is thus in some respect being more aggressive with MBS than with Treasury debt. That suggests the spread could continue to narrow.
To sum up, there is no reason to worry:
- Although Treasury yields have moved higher over the past several months, they remain at extremely low levels.
- The current spread between mortgage rates and Treasury yields is not out of the ordinary, even with the recent runup in Treasury yields.
- The Federal Reserve continues to purchase agency MBS on a monthly basis. I do not think the Federal Reserve will shift course anytime soon. Don’t fight the Fed.
- The economic recovery and its effect on housing, combined with low mortgage rates, will support continued robust mortgage origination volumes.