Mortgage Bonds Control Mortgage Rates, Not The Ten-Year Treasury Note

Joe Dahleen reported that mortgage rates are up sharply.  That’s true if you compare them to this time last week.  His advice, for homeowners wishing to refinance was dead on:

If you are the process of refinancing then get your ducks all lined up and have your loan file clear to close before you LOCK and DOC. This way you can time the market to take advantage of the lowest possible rate and take the shortest term LOCK and save more money.

I can’t argue with that advice; it’s perfect.  Mortgage rate locks cost money.  A lender “charges you” an extra .375% in discount points for a longer lock.  Why?  The lender has more “risk” guaranteing you a certain rate for a full month than it would for a week and a half.  When Joe told you to get fully approved so you could “pounce”, it was excellent advice.  Here’s where Joe may have inadvertently slipped:

So keep your eye on the 10 year treasury rates.

I think that was an unintentional slip. Seasoned originators know that the ten-year treasury note does not directly influence mortgage rates, the mortgage-backed securities market does.  I addressed this over on Bloodhound Blog:

Why am I so adamant about the fact that the ten-year treasury note is not the determining factor of mortgage rates?  The statement is factually incorrect. While the two securities often move in concert, polarity can occur and sometimes does; this is one of those times.  The ten-year T-note is considered the benchmark, not bellwether fixed-income security.  This means that all other securities are compared to the 10-year T-note (we call that the “spread”).  It is GENERALLY a guiding indicator of ALL rates, however, in times or crisis or exuberance, it can’t be relied upon for other fixed-income securities’ direction.  Spreads to the T-note widen and narrow due to extraneous variables.

Yesterday’s post market trading is a prime example of this phenomenon.  While the ten-year bond yield fell about .1% today, the spread, or difference between the 10 year bond yield and mortgage bonds market narrowed, dropping .2% in yield.  From Bloomberg:

The difference between yields on Fannie’s current-coupon 30- year fixed-rate mortgage securities and 10-year Treasuries fell 11 basis points to 190 basis points as of 4:15 p.m. in New York, data compiled by Bloomberg show. A fall in yields on the securities suggested a decline in interest rates on new home loans of about 20 basis points, or 0.20 percentage point.

Consider the analogy of a dog on a leash.  The owner is the ten-year treasury note while the dog is the mortgage bonds market.  Some days, when the dog is feeling frisky, it runs away from its owner.  Should it get too far, the owner tugs on the leash and the dog comes running back.  Mortgage bonds have been running from the owner for the past two weeks; investors thought they were risky.  Today, that leash got tugged and spread between mortgage bonds and the ten-year note narrowed.

Does this really matter?  It does if you want the best rate execution.

Fewer than 15% of all mortgage originators subscribe to a mortgage-baced securities pricing service which means you have an 85% chance of receiving the wrong advice.  Sue Woodard of the Mortgage Market Guide,  suggests that a mortgage professional should be able to answer these four questions:

1- What are mortgage interest rates based on?  This article answers that question for you

2- What is the next economic report that could cause interest rate movement?  You can track those numbers on Bloomberg’s calendar of economic figures.

3- When the Fed “changes rates”, what does that mean and how will it affect mortgage rates?  Sometimes, mortgage rates actually go UP after a Fed cut.

4- What’s happening in the mortgage bonds market today and what do you see in the near-term future?  For that answer, you can read my mortgage rates report.

Joe gave excellent advice about “getting your ducks in row” so you’re prepared to take advantage of the volatility of the market; let’s just keep our eyes on the correct market.

October 16, 2008