Bond Yields & Mortgage Rates No Longer Related
A: I want to touch on this topic as I have been asked recently why mortgage rates are not falling as much as 10YR Bond yields have? In the past there was a much closer relationship between 10YR bond yields and lending rates, but something changed. Risk joined the party. As a result, investors deemed mortgage related security products much riskier than in the past and would only be interested if the yield that came with this riskier bet was increased. For main street, any debt that is related to the current fear of delinquency & default risk, comes with a higher borrowing cost. In this new world where risk has been re-priced, that is the key term here, bond yields are no longer a reliable indicator to the future direction of lending rates. Instead, lending rates will be more closely tied to the evolving credit crunch and will act more on credit history than ever before!
Lets see what I mean. The simplest way to get statistical evidence of what I just said, we must look at how 10YR bond yields & NY 30 YR Jumbo mortgage rates have performed over the past month or so! Lets no forget that things have changed significantly over the past 30 days as the credit crunch worsened, stocks sold off, bond yields plunged, and yet lending rates went higher. Here are my sources:
BANKRATE.COM: showing the trend of NY 30YR Fixed Jumbo mortgage rates; 1 month
MARKETWATCH.COM: showing the trend of 10YR Treasury Yield; 1 month
I merged the two line charts onto one graph that shows:
a) the downward trend of 10YR bond yields
b) the upward trend of 30 YR Fixed Jumbo rates
I don't know how much more clear this point can get! During times of credit distress, your credit rating will be more important than ever in deciding how low of a rate you can get on a loan as lenders try to clean up their books, tighten lending & underwriting standards, and assign a higher rate to riskier borrowers!
My friend and fellow blogger Dan Green will support this theory now, but argued with me a number of times in the past before the credit crunch invaded; where I often showed you charts relating the 10YR bond yields to mortgage rates.
Dan discussed recently, "Where Mortgage Rates Come From", and stated:
Mortgage rates are "made" from the price of mortgage bonds using a mathematical bond formula. This is fact. And by exclusion, this also means that mortgage rates do not come from the price of the 10-year treasury note.So, at least there is one agreeable point here: 10 YR TREASURY YIELDS ARE NO LONGER RELATED TO LENDING RATES; ESPECIALLY JUMBO RATES! At least Dan provides an actual answer to where rates are linked to, the fixed rate mortgage backed securities (via The Mortgage Market Guide). Does your loan officer have this tool for real-time reporting? I'd certainly be surprised if they did.
So, let's hammer the point home. As of 2:00 P.M. ET yesterday (Nov. 20th), the U.S. treasury market was rallying. The bond market looked good from 30,000 feet. A check into the mortgage bond market, though, showed that mortgage prices were getting killed, off 25 basis points.
This is about the same time that my inbox starting dinging with new mortgage rate sheets reflecting higher rates from our nation's lenders. I wasn't surprised by the reprice for the worse because I had been watching the market slowly slip away on my MBS ticker all day. I had ample time to contact a few clients and get them locked in at lower rates before the reprice.
Posted by spaceboy
Tue Nov 27th, 2007 04:55 PM
Perhaps they are not as tightly correlated as in the past, but I think there is still a lagging trend for the jumbo's against the fed funds rate. After the fed emergency cut, the jumbo's did eventually also drop 50 basis points, but it took a month or so. I think the last fed 25 basis point cut is also slowly starting to be accounted for now in the mortgage rates. Correct me if I'm wrong. I think we'll know if my theory is possible in a few more weeks.
Posted by Noah
Tue Nov 27th, 2007 04:59 PM
spaceboy - possible. Although I think the 5o basis point cut was a bit of a suprise, and markets reacted more aggressively in reponse to it. The latest 1/4 cut, was as expected.
Posted by GS
Tue Nov 27th, 2007 05:50 PM
This is true for jumbo rates, but not at all for a regular 30 yr fixed. Those rates are moving step for step with the 10 year as much as they ever have.
Granted, in NYC that doesn't mean much, but for a lot of the country it means rates have been falling a substantial amount.
Posted by Noah
Tue Nov 27th, 2007 05:59 PM
GS - good point. Almost all deals here are Jumbo's so I tend to use that for most discussions on the topic.
Thx for bringing that up though.
Posted by Dan Green
Wed Nov 28th, 2007 03:06 PM
Thanks for highlighting my post, Noah. It's true -- we've "discussed" this in the past, but I really like your assessment of the re-pricing of risk. In the end, isn't that where ALL security prices are born?
Anyway, today was another day where the 10-year and the MBS market diverged. As of right now, MBS is up 12 basis points and the 10-year treasury note is down 56 basis points.
If a loan officer is watching the wrong indicator today, he's locking loans for clients when a float could be the better option.
Posted by Noah
Wed Nov 28th, 2007 09:34 PM
Dan - can you describe a float?
Posted by DM
Mon Dec 3rd, 2007 03:17 AM
Noah,
Brokers have two options when submitting a loan to a lender. They can register the borrower's information and choose to "lock" the rate, or they can "float" the rate and choose a rate at a later time. Once a rate is locked, future market movements become irrelevant whether higher or lower in rate. The rate is locked in to protect a borrower from rate movement during the underwriting process, which can take as long as 30 days. this enables a broker to promise a specific rate and deliver it by locking in that rate with the lender. The only downside is that most borrowers want to have it both ways. they want rate protection should rates get worse and lower rates should rates get better.