The gap between 10-year Treasury Note and 30-year mortgage rates has widened.
As a reminder, when we speak about spreads, we are not referring to cream cheese. If you want to know about the future of mortgage rates and how quickly they might fall, it is not enough to study the economic news such as the jobs and inflation reports. It also concerns the spread between government instruments, particularly the 10-year Treasury Note and mortgage rates. First of all, why is there a “spread”? Mortgage rates are higher than Treasurys issued by the government because there is a greater risk of default. The spread gets wider when the risk of default goes up, for example during recessions or in times of great uncertainty. But there are also other factors such as supply/demand and prepayment risk.
When the pandemic hit, the Federal reserve started purchasing large amounts of Treasurys and mortgages. In 2022, in addition to raising short-term interest rates, the Fed also stopped purchasing these instruments. Thus, a big buyer was removed. Meanwhile, with rates increasing there is more uncertainty than ever in the markets. This uncertainty has hit mortgages more sharply than Treasuries which are backed by the government. Plus, we had regional banks go under and their mortgage holdings are being sold in the market, increasing supply. This just adds to the recent extra supply of sales as the government is playing catch-up after the debt ceiling deal, with a ton of Treasuries hitting the markets.
The result? A normal spread of around 2.0% has become a bit more than 3.0%. With the 10-year Treasury between 3.5% and 4.0%, 30-year mortgage rates should be in the range of 5.5% to 6.0%. Instead, in late June 30-year mortgage rates were closer to 7.0%. The good news is that, as interest rates fall, if these spreads narrow as well, mortgage rates will fall faster than Treasury rates. Will interest rates fall? Going back to economic news, this week’s jobs report will be watched closely to see if the rate of job creation finally slows down, along with wage growth. Stay tuned.