Mortgage Rates and the 10-Year Yield
Sovereign Lending Group (SLG) and our clients have observed the fast rise in mortgage rates in 2022 with alarm, as has the rest of our industry. Treasury yields have gone up as well, leading some to ask, “What is the link between the two, and how much are mortgage rates going to go up?”
SLG thinks that our clients should know that the 30-year benchmark mortgage rate primarily reflects two components: the yield on intermediate- to longer-term Treasury securities, and a spread that tends to fluctuate over time. The Federal Reserve has held Agency mortgage-backed securities (MBS) on its balance sheet since early 2009 and Fed purchases of these securities, driving prices up and yields down, have pulled down the yield on the benchmark 30-year MBS by roughly an estimated 50 basis points since 2009.
Even though Fed officials have indicated they will allow their MBS holdings to decline in coming months, this will not necessarily cause mortgage rates to shoot even higher as markets are forward-looking. To some extent, the recent mortgage spread “widening” is consistent with markets accounting for smaller Federal Reserve MBS holdings going forward. Additionally, Fed MBS purchases in recent years have pulled MBS yields lower than actual mortgage rates, meaning it is reasonable to expect that MBS yields will face more upward pressure than actual mortgage rates as balance sheet runoff progresses.
Since mortgage rates are separate from Treasury yields, is it fair to ask how much higher will the yield on the 10-year Treasury note rise? While yields on U.S. Treasury securities could potentially rise even further, the recent surge in the 10-year Treasury yield should slow markedly in the coming weeks, which should dampen upward pressure on mortgage rates.
SLG’s management believes that there is a significant amount of near-term monetary policy tightening already priced into the market. Longer-term, markets appear priced for a fed funds rate that is closer to “neutral.” There are wide confidence intervals around estimates for both the timing and the magnitude of the impact from balance sheet runoff, and it is unlikely balance sheet runoff has been fully priced in yet. Odds are it is discounted by more than many might suspect, given that the process has not even yet begun. SLG has seen, over the past several months, how the economic outlook and expected path of monetary policy can change rapidly.