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Why Mortgage Rates Are So Darn High

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Of course, mortgage interest rates are going up. But how much? It needs an explanation.

Freddie Mac Weekly Average 30 Year Fixed Mortgage Rates Cracked 7% For the first time in 20 years, it rose just 4 percentage points from the end of last year. By contrast, the benchmark 10-year Treasury yield is up about 2.5 percentage points. What this means is that the gap between mortgage rates and Treasury yields, or the spread in financial terms, has widened.

Over the past 10 years, the gap between national average mortgage rates and 10-year Treasury yields has averaged 1.8 percentage points, according to figures tracked by Autonomous Research. This year started on just that level. But with US Treasuries yielding over 4%, the current spread is around 3 points, about the same high as it has been this century.

Spreads similarly widened in late 2008 and March 2020, when the financial crisis and pandemic respectively drove investors into the haven of Treasuries. In both cases, the Federal Reserve cut spreads and mortgage rates, similar to mortgage bond spreads, and stepped up to buy more mortgage bonds. is an important component The mortgage interest rate that is ultimately charged to the borrower.

Not this time. The Fed stopped buying agency mortgage-backed securities this year as part of a plan to shrink its balance sheet. These are mortgage packages issued by government-backed companies such as Freddie and Fannie Mae.

What’s more, the Fed’s overall tightening of monetary policy has led to a decline in bank appetite for bond purchases. As interest rates rise, the number of people refinancing their mortgages and paying them off early has dropped dramatically. This increases the life expectancy of mortgages and MBS. But if bank deposits tend to repricing quickly in response to rising interest rates, long-duration assets become less attractive.

Banks and the Federal Reserve together own about 75% of the agency MBS market, according to Bank of America strategists. Without these buyers, that market has become more volatile and has also contributed to widening spreads between MBS and Treasuries.

Investors may be tempted by wide spreads on MBS, but one concern that is keeping buyers away is that the gap could widen further as the Fed battles inflation. “In the past few sessions, there has been enough investor interest to keep spreads down, but not enough to tighten them,” she said. “The risk is that without that demand, spreads could widen.”

Another component of mortgage rates is what mortgage originators get from selling mortgages into the market. The proxy for this is the spread between the rate charged to the borrower and the current yield on her MBS. With volumes plummeting and volatility soaring, originators needing to protect their economies are often not in a position to offer low mortgage rates to attract borrowers.

Morgan Stanley analysts noted in late October that agency MBS spreads were closer to their widest post-corona levels than corporate credit spreads, which have been roughly in the middle of the range since May 2020. . The difference, analysts said, was that banks were major buyers of his MBS, but generally not big buyers of corporate credit. The relative widening of MBS spreads is a result of banks trying to manage their balance sheets, they said.

One silver lining for mortgage bonds, and therefore mortgage borrowers, is that financial institution MBS may outperform other credits in a recession. The fact that MBS spreads are now wider than credit spreads on companies commonly suffering from recessions compared to recent history could even accelerate that impact.

Still both with the Fed increase rate With no longer buying mortgage bonds and house prices generally in the central bank’s crosshairs, it’s no wonder they’ve done little to keep mortgage rates down so far.

Writing to Telis Demos: [email protected]

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