Mortgage Rates Stay Elevated

Nasdaq dumps

Before we get into settlements and our trackers let’s take a look at this chart of 30Y fixed rate mortgage rates vs the US Government 10Y:

We are witnessing a breakout of this spread to multi decade highs. Magnelibra has a few points to decipher as to why this may be occurring.

• Duration extension. We believe this is the main driver of this spread between mortgage rates and 10 year Treasury yields. The data suggests that 70% of all mortgages are currently below 4%. This means that there is very little incentive for homeowners to refinance their mortgages, what this does is that it extends the duration of mortgage paper, because there is zero incentive to refinance and create new loans. As a result, there is less demand for mortgage-backed securities (MBS), which are the underlying assets that back most mortgages. This lower demand for MBS has pushed down their prices, which has led to higher mortgage rates.

• Fed's quantitative tightening. Another factor that is contributing to the widening spread is the Federal Reserve's quantitative tightening (QT) program. QT is a process by which the Fed reduces the size of its balance sheet. This is done by selling Treasury securities and mortgage-backed securities. As the Fed sells these securities, it reduces the demand for them, which pushes down their prices and leads to higher mortgage rates.

• Economic uncertainty. Finally, economic uncertainty is also playing a role in the widening spread. The war in Ukraine, rising inflation, and the potential for a recession are all weighing on investor sentiment. This leads to a potential demand for US Treasury securities and other safe assets (think MEGACaps). This consistent long end demand for US Treasury securities has pushed up their prices and led to yields staying lower in the long end especially vs the Fed Funds and shorter duration treasuries.

• Changes in risk premiums. The spread between mortgage rates and 10 year Treasury yields can also be affected by changes in risk premiums. Risk premiums are the extra yield that investors demand for holding riskier assets. If investors perceive mortgages to be riskier than Treasury securities, they will demand a higher risk premium, which will lead to higher mortgage rates.

• Changes in the supply of mortgages. The supply of mortgages can also affect the spread between mortgage rates and 10 year Treasury yields. If the supply of mortgages decreases, it will lead to higher mortgage rates. This could happen if there is a decrease in the number of lenders offering mortgages or if there is an increase in the number of borrowers who are unable to qualify for a mortgage.

We wanted to cover this topic because we believe that mortgage rates are subject to continued increases in yield even if US Treasury yields stay sub 5% thus keeping this spread greater than 2.5% for some time. The higher for longer FRB rhetoric combined with an economy that still hasn’t seen one negative non farm payrolls print means higher rates than the last decade seem to be fully anticipated now.