MBS Live Day Ahead: Why The Range Risk in Treasuries Matters to Mortgages

There was a time in the very recent past when we could almost completely ignore the implications of 10yr Treasury yield movement on mortgage rates.  While this was definitely a break from the historical norm, it wasn't a completely foreign exercise given the massive divergences seen at times in the past.  

Those divergences resulted from big news and big changes to MBS valuation considerations, whether it was the mortgage meltdown or the Fed stepping in with the mortgage-specific QE3 purchases.  Most recently, it was the mortgage-specific impacts from coronavirus. 

Simply put, while the US government's ability to make payments on Treasuries was at no risk of changing, the cash flows back to MBS investors from pools of underlying mortgages were at serious risk.  As such, mortgage rates spiked significantly and paradoxically in March.  Since then, they've only slowly been returning to a more stable relationship with Treasuries.  But as of the past few weeks, it looks like that relationship is re-solidifying.  

We can see this in the following chart which shows the average daily 30yr fixed rate versus 10yr Treasury yields (something a lot of people mistakenly believe mortgage rates to be based on).  The second part of the chart plots the actual spread between the two.  I've said for months that mortgage rates are likely to sustain some semi-permanent damage versus their bond market benchmarks and this chart suggests that's already being confirmed (due to the spread now moving sideways at historically elevated levels).

With that spread stabilizing, we can begin focusing more on Treasuries for their normal function of guidance giver in chief for longer-term rates.  In fact, I've already been doing that for about a month now for just this reason.  While there's no doubt that the trend in yields has been friendly, there is some emerging doubt as to how willing they are to break below the range floor at .58%.  

This .58% business could prove to be just a temporary speed bump.  But until and unless we see yields move below it and remain in stronger territory, it suggests bonds and mortgage rates may take some time to consolidate or even correct toward slightly higher levels before doing whatever they're going to do next.