May 11th, 2018 2:06 PM by Narbik Karamian
Here is a simple version of how mortgage rates are closely tied to the movement of the 10-year Treasury. Hope you find it informative.
Interest rates are at their lowest when the 10-year Treasury yield is at its lowest.
We saw mortgage rates at their lowest point on July 8, 2016 when Great Britain voted to leave the European Union. The 10-year Yield hit 1.37%.
The yield rebounded after Donald Trump won the 2016 presidential election. Investors felt his tax cuts would create jobs and boost the economy. That's when investors switch to stocks and real estate investments. By the end of December, 2016, the 10-year Treasury yield rate climbed to 2.45 percent.
U.S. Treasury bills, bonds and notes directly affect the interest rates on fixed-rate mortgages. How? When Treasury yields rise, so do interest rates. That's because investors who want a steady and safe return compare interest rates of all fixed-income products. They compare yields on short-term Treasury’s to certificates of deposit and money market funds. While, they compare yields on long-term Treasury’s to home loans and corporate bonds. All bond yields are affected by Treasury yields since they compete for the same type of investor as the stock market.
Treasury notes are safer than any other bonds because the U.S. government guarantees them.
CDs and money market funds are slightly riskier since they aren't guaranteed. To compensate for the higher risk, they offer a higher interest rate. But they are safer than any non-government bond because they are short-term. Businesses typically store their cash in money market funds overnight. It gives them a safe place to park their excess funds for a little bit of a return.
That's why the precursor to the 2008 financial crisis was September 15, 2008. That was the day a money market fund almost went broke.
Mortgages offer a higher return for more risk. Investors purchase securities backed by the value of the home loans. These are called mortgage-backed securities. When Treasury yields rise, banks charge higher interest rates for mortgages. Investors in mortgage-backed securities then demand higher rates. They want compensation for the greater risk.
Those who want even higher returns purchase corporate bonds. Rating agencies like Standard and Poor's grade companies and their bonds on the level of risk.
The U.S. Treasury Department sells bills, notes and bonds to pay for the U.S. debt. It issues notes in terms of two, three, five and 10 years. Bonds are issued in terms of 30 years. Bills are issued in terms of one year or less. People also refer to any Treasury security as bonds, Treasury products or Treasury’s. The 10-year note is the most popular product.
The Treasury sells bonds at auction. It sets a fixed face value and interest rate for each bond. If there is a lot of demand for Treasury’s, they will go to the highest bidder at a price above the face value.
That's because the bidder has to pay more to receive the stated interest rate. If there is not a lot of demand, the bidders will pay less than the face value. That increases the yield. The bidder pays less to receive the stated interest rate. The yield is higher in this case, so it can attract more investors to buying Treasury bonds. That is why yields always move in the opposite direction of Treasury prices.
Treasury note yields change every day. That's because investors resell them on the secondary market. When there's not much demand, then bond prices drop. Yields increase to compensate. That makes it more expensive to buy a home because mortgage interest rates move in the same direction as Treasury yields. Buyers have to pay more for their mortgage.
Low yields on Treasury’s mean lower rates on mortgages. Homebuyers can afford a larger home with the same income. The increased demand stimulates the real estate market. That boosts the economy. Lower rates also allow homeowners to afford a second mortgage. They'll use that money for home improvements, or to purchase more consumer products. Both stimulate the economy.
When Rates First Fell to an all-time low
On July 8, 2016, the yield on the 10-year Treasury note briefly dropped during intraday trading to 1.37 percent, the lowest in maybe 200 years. In a couple of days, the rate started to move a bit higher. Another similar situation occurred between July 23-25, 2015. Many of our clients were able to take advantage of buying or refinancing during these two times into very attractive rates.
Why was the yield so low? Investors panicked when the jobs report come in lower than expected. They also worried about the eurozone debt crisis. They sold stocks, driving the Dow down 275 points. They put their cash into the only safe haven, U.S. Treasury notes. Gold, the safe haven in 2011, was down thanks to lower economic growth in China and the other emerging market countries.
Investors still hadn't recovered their confidence from the stock market crash of 2008. Also, they were uneasy that the federal government would allow the economy to fall off the fiscal cliff. Add in the uncertainty around a presidential election year, and you had a situation that you hope will never occur for another 200 years.
The yield rose as high as 2.90 percent between May and September 2013. The yield started rising after the Fed announced it would taper its purchases of Treasury’s and other securities. The Fed had been buying $85 billion a month since September 2011. This was part of its quantitative easing program. This was an artificial way of keeping the demand for Treasury bonds strong and allow for the yields to stay low to help the U.S. economy to recover. The Quantitative Easing also kept mortgage rates very low to encourage home buying as Real Estate plays a pivotal role in the economy.
Below is a historical graph of the 10-year Treasury Yield from 1790.