Mortgage rates are rising much faster than Treasury yields. What is the problem?
Is this gap heading towards what happened in the 1970s and 1980s when the Fed battled runaway inflation?
By Wolf Richter for WOLF STREET.
The average 30-year fixed mortgage rate tracks the 10-year Treasury yield, running roughly in parallel but higher. It tracks the 10-year yield, as the average 30-year mortgage is paid off in just under 10 years, either through the sale of the home or a refi. But they don’t move in parallel, and the difference between the two – the spread – has widened sharply, with mortgage rates suddenly rising much faster than the 10-year yield.
The 10-year US Treasury yield has soared since the Fed made its infamous “pivot” in the fall of 2021, moving from deliberately ignoring and assiduously eliminating the incredible surge in inflation to real, if lukewarm at first, recognition of its existence and persistence.
In August 2021, the 10-year yield was still around 1.3%. Today it is 2.34%, after gaining 1.03 percentage points in seven months. Over the same period, the average 30-year fixed mortgage rate, as tracked by Freddie Mac, jumped 1.55 percentage points, from 2.87% to 4.42%:
The chart above shows what happened during the mayhem of March 2020, when the Fed cut its key rates to nearly 0% and announced a huge QE program that sent the Treasury yield down to 10 years (green line), while mortgage rates just continued their methodical decline that lasted until December 2020.
This mortgage rate cut was launched in late November 2018, when Powell, being hammered daily by Trump, relented and announced that the Fed would soon stop tightening.
At the time, inflation was below the Fed’s target, and the Fed was raising rates that were already above CPI and it was shrinking its balance sheet at a rate of about $50 billion per month (QT). Housing was hit and stocks were crashing, and Trump, who had taken over the Dow Jones, had it.
The fact that the 10-year yield plunged in March 2020 while mortgage rates were only slowly falling caused the spread between the two to explode. It peaked at the end of April at 2.73 percentage points.
The average 30-year fixed mortgage rate continued to decline until reaching an all-time low in December 2020 of 2.66%.
But the 10-year Treasury yield had started to rise four months before mortgage rates began to rise, bouncing off its all-time low of 0.55% in August, causing the spread between the two to narrow. In December 2020, when mortgage rates bottomed out, the 10-year Treasury yield rose to 0.9%. And the gap has continued to narrow in 2021.
Part of what contributed to very low mortgage rates in 2021 was the narrow spread between the 10-year Treasury yield and 30-year mortgage rates. At the time, it was between about 1.3 percentage points and 1.6 percentage points.
But in January 2022, the spread suddenly started to widen, with mortgage rates rising much faster than Treasury yields. At the latest weekly mortgage rate, the spread reached 1.81 percentage points, after reaching 2.09 percentage points in early March. Note the increasing volatility of the spread:
Long-term models show how wide the gap can widen. The massive expansion of March 2020 and during the financial crisis happened because the Fed aggressively belittle Treasury yields while mortgage rates lagged.
But between the mid-1970s and the mid-1980s, the Fed was aggressive push up Treasury yields to fight the markets with rate hikes. And mortgage rates in 1980 – as now – exceeded the 10-year Treasury yield as lenders tried to keep up with inflation. Eventually the Treasuries caught up, then there were massive rate cuts, followed by more massive rate hikes, followed by massive rate cuts, and the spread exploded and narrowed with huge volatility:
The current situation – incredibly high inflation that the Fed is belatedly taking seriously – is much closer to the scenario of the 1970s and 1980s than to the financial crisis and the crisis of March 2020. In the last two, spreads have widened. widened because the Fed drove down Treasury yields as mortgage rates lagged. Now the gap is widening because mortgage rates are ahead and rising faster than the 10-year yield. It is likely that the spread will be very volatile and potentially very wide during certain periods, with mortgage rates potentially exceeding Treasury yields by a wide margin during these periods, before Treasury yields catch up or mortgage rates retreat. .
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