Mortgage Rates Disconnected from Treasuries

Mortgage rates have been on a wild ride lately, leaving homebuyers and homeowners alike feeling whiplashed. Rates have rocketed up to levels not seen since the spring of 2000. The average 30-year fixed mortgage is now well over 8%, more than double what it was just two years ago.

With mortgage rates more than 1.5 percentage points higher than they historically "should" be based on 10-year Treasury bond yields, many are left wondering – what's driving this unprecedented surge? Typically, mortgage rates closely correlate to 10-year Treasury yields. But right now, an invisible force has widened a massive gap between Treasuries and mortgage rates.

The Bond Market Frenzy

The root cause ties back to an out-of-control bond market. Demand for bonds has plummeted, thanks to the Federal Reserve's quantitative tightening and decreased foreign appetite. Yet the supply of bonds has exploded due to government deficit spending.

With supply far outpacing demand, bond yields have shot up dramatically to attract reluctant buyers. The 10-year Treasury yield has surged from mid 3% earlier this year to 4.7% now. Since mortgage rates closely track the 10-year Treasury yield, this bond market frenzy directly fuels rising mortgage rates.

Impacts on Mortgage Rates

As Treasury yields continue exploding higher, lenders pass along the inflated rates to mortgage borrowers. This translates directly into higher mortgage rates for anyone looking to purchase a home or refinance their existing home loan.

Mortgage rates are now 1.5 percentage points above where they should be based solely on the underlying 10-year Treasury benchmark. This premium reflects the chaotic bond market conditions and uncertainty about where yields are headed next.

Concerns Over Fed Tightening

The Fed aims to tighten financial conditions to tame inflation. However, runaway yields threaten to overtighten, severely restricting credit and business investment critical for economic growth.

The housing market is the most visible victim, with unaffordable home prices and mortgage rates squeezing buyers out. New housing construction and sales are slowing. Existing homeowners face massive barriers to refinancing into lower rates.

Uncertainty Fuels Rate Volatility

Uncertainty about the Fed's future policy actions adds fuel to the mortgage rate fire. Markets expect the Fed to pivot soon to a more dovish stance to rein in runaway bond yields. This would likely stabilize rates and provide relief to battered borrowers.

But the Fed remains stubbornly hawkish thus far, publicly aiming for higher rates for longer to crush inflation. This disparity between market hopes and the Fed's aggressive posture further inflates mortgage rates.

Waiting for Yields to Stabilize

Until Treasury yields stabilize, it's unlikely mortgage rates will steady. The Fed must walk a precarious tightrope between reducing inflation and avoiding recession.

Yet runaway yields restrict its ability to engineer a “soft landing” where inflation drops while growth continues. As yields rapidly rise, the Fed may be forced to step in to avert turmoil.

Bottom Line

The bond market turmoil also demonstrates the intricate interconnections within the financial system. Tugging on one thread like quantitative tightening can unravel yields, mortgage rates, housing affordability and more.

While the Fed publicly maintains its hawkish tone, expect dovish pivots if bonds continue detonating. Once supply and demand rebalance, yields should moderate. This will provide welcome relief for homebuyers battered by sky-high mortgage rates.