MBS Live Day Ahead: Are Mortgage Rates Done Closing The Gap To MBS?

We've talked a lot about the massive rift that opened up between mortgage rates and MBS yields as the pandemic hit markets several months ago.  MBS yield isn't something we've historically focused on largely because it's not important to follow for the purposes of our core audience.  But apart from something like 10yr Treasury yields, it provides the least complex comparison between bond market movement and mortgage rates.

While the comparison may be relatively simple, the thing itself is less so.  If we're talking about the "current coupon" yield (which we need to be in order to examine longer-term relationships between MBS and rates), and given the lack of a liquid discount MBS coupon (i.e. nothing is actually trading under a price of 100.00, which is something a "current coupon" calculation needs), we're talking about something that relies on a proprietary calculation that can vary depending on who's doing the math.  Fortunately, our friend Adam Quinones is the guy doing the math, and that means we can rest assured it's the best of the best.

Back to "the rift."  It's been closing, albeit slowly, and that's been a boon for rates.  The bigger the rift, the bigger the combination of origination costs and lender margins.  Those increased costs and margins were a logical byproduct of the drama seen in the mortgage market in response to covid and forbearances.  It's also logical that the rift would shrink over time--something it's definitely been doing.  That's directly responsible for mortgage rates making it to successive all-time lows even as Treasuries are nowhere near their all-time lows from earlier this year.

But here's the bad news.  As I've warned incessantly, the historically normal relationship between MBS and mortgage rates may have been permanently (or semi-permanently) damaged by covid.  We don't know if that will be the case yet, but it's still entirely possible.  And now the chart is bouncing in such a way that keeps that fear alive.

It's ENTIRELY possible that this bounce is simply "noise" in the bigger picture and that it will eventually get lost in the shuffle.  But until that's proven out, this is visual proof of the cautionary tale I've been telling you for weeks.  Simply put, we can't rely on this excess spread between rates and MBS to help insulate mortgages against broader bond market movement going forward.  In other words, mortgage rates aren't playing against Treasuries with the same advantage seen in the past 3 months and any glacial shift toward higher Treasury yields would have an easier time translating to an equivalent shift in mortgage rates.