Do mortgage rates follow movements in Treasury yields?
Do mortgage rates follow movements in Treasury yields? (Part 1 of 9)
Mortgage rates and Treasury yields
The period from September 2012 to the present has been unconventional for U.S. fixed income markets. The unprecedented scale of monthly bond purchases ($85 billion per month initially), longer-term US Treasuries, and agency-backed securities by the U.S. Federal Reserve, and the subsequent curtailment of the same (reduced by $10 billion each in December 2013, January 2014, and March 2014, to $55 billion currently), has produced some unexpected reactions in bond markets.
Correlations between mortgage rates and Treasury yields
The historical correlation between the percentage change in weekly market yields on 30-year U.S. Treasury securities (TLT) and the percentage change in weekly interest rates for 30-year conventional mortgages between January 2007 and mid-March 2014 was computed at 0.51. The correlation between the percentage change in market yields for ten-year Treasury securities and the percentage change in interest rates for 30-year conventional mortgages for the same period came in even higher, at 0.62. Changes in the yield on ten-year Treasuries (IEF) correlate even more with changes in mortgage rates, as the effective duration of a 30-year mortgage is considerably lower and is nearer the ten-year maturity of the Treasury bond than the 30-year bond. This is because of the principal prepayment option present in most mortgages
(MBB), which mortgage holders frequently exercise when rates are falling.
The relatively high correlations imply a significant relationship between changes in interest rates for Treasury securities (TLT) and interest rates for 30-year conventional mortgages (VMBS).
Since the U.S. government bailed out federal home loan agencies, the Federal National Mortgage Association (Fannie Mae or FNMA) and Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) in 2008, the credit risk of mortgage-backed securities (or MBS) issued by home loan agencies has been linked to U.S. government debt, and therefore Treasury securities. FNMA and FMCC act as intermediaries, providing funding for home loans and then repackaging the resultant mortgages and selling them to investors as mortgage-backed securities. So these entities influence the mortgage market significantly. Since the U.S. government bailout in 2008, their debt has been rated equivalent to U.S. government debt (read:Treasury securities). So yield movements for the two types of debt follow similar patterns.
This series will analyze how mortgage interest rates have behaved with respect to Treasuries and the reasons for this correlation. In particular, we’ll look at how changes in interest rates for ten-year and 30-year Treasury securities have impacted 30-year conventional mortgage rates.
To read about how the Fed’s accommodative monetary policy in early 2013 affected Treasury and mortgage rates, read on to Part 2 of this series.Source: finance.yahoo.com