Analysis
Mortgage bonds behave differently from ordinary bonds because homeowners can repay early. When rates climb, fewer people refinance, so the bonds last longer and become more sensitive to rate moves, and their owners often respond by trading in Treasury or swap markets. Reuters reports that this hedging has picked up in recent weeks, while analysts it quotes say the effect is likely smaller than in earlier selloffs. The same rate rise is also feeding through to the mortgage rates households are offered.
What happened
Reuters reported on October 12 that the sharp rise in long-term U.S. Treasury yields has spurred mortgage-related hedging that adds selling pressure to an already strained bond market, though analysts expect the impact to be smaller than in past selloffs. It said 10-year yields have risen about 130 and 30-year yields about 100 basis points since late February, reflecting a war-driven oil-price spike that has raised expectations of several Federal Reserve rate increases over the next 12 months. [1] A is one-hundredth of a percentage point.
Treasury's official daily figures put the 10-year at 5.24% and the 30-year at 5.60% on Friday, October 9, the latest date in its table when this was written. Over the first seven trading days of October the 10-year ranged from 5.22% to 5.31%. [3]
How mortgage hedging works
A mortgage-backed security (MBS) is a pool of thousands of home loans whose monthly principal and interest payments pass through to investors. Because homeowners can refinance or sell and repay early, how long an MBS stays outstanding depends on interest rates. When rates rise, fewer people refinance, so the expected life of these securities extends, which makes them more sensitive to further moves in yields. [1]
Investors often respond by selling Treasury futures or by buying interest rate swaps, contracts that exchange a fixed payment for a floating one. The practice is called convexity hedging, and it shortens the duration of what they hold; duration measures how much a bond's price moves when rates change. Reuters notes that this hedging has often reinforced bond selloffs, because the hedgers sell into a market that is already falling. [1]
Signs of hedging
Mike Riddle, chief executive of Eris Innovations, a Chicago-based developer of futures products, told Reuters that by the first week of October nine very large block trades had been executed in Eris swap futures listed by CME Group tied to the (SOFR), each carrying at least $200,000 of exposure to a one-basis-point move in rates. Open interest in those contracts reached a record 866,768 on September 21, more than double the previous year's level, Reuters reported. [1]
Reuters also cited a research note from Annaly Capital Management, one of the largest mortgage real estate investment trusts, saying MBS underperformed Treasuries of comparable duration by 96 in September, their weakest month since the March 2023 banking turmoil. AGNC Investment Corp. said mortgage spreads to Treasuries widened about 13 basis points in September to 125 basis points. Analysts told Reuters that such underperformance is consistent with more hedging. [1]
Riddle said many mortgages made over the past three years carry rates relatively close to today's, so if mortgage rates keep climbing, the expected life of those loans could change meaningfully, likely requiring more hedging and more Treasury selling. [1]
Why the effect may be smaller this time
Analysts quoted by Reuters said the effect tends to fade as yields rise, because more mortgages become locked in. Amrut Nashikkar, head of derivatives strategy at Barclays, said more and more of the MBS market is significantly out of the money, meaning borrowers have no incentive to refinance, which makes further selloffs less destabilizing. Neil Sun, a portfolio manager at BlueBay Asset Management, said that if rates stabilize at current levels, the biggest selling pressure may be behind the market. [1]
James Wang, head of macro at U.S. Bank, said the mortgage market is much smaller than the one that amplified bond swings before the 2008 financial crisis. Fannie Mae and Freddie Mac, the biggest hedgers before the crisis, have shrunk their mortgage portfolios significantly since then, Reuters noted. "At the end of the day, monetary policy expectations are the No. 1 driver of the selloff," Wang said. [1]
What mortgage borrowers are seeing
Freddie Mac's weekly survey, published October 8, put the average 30-year fixed rate at 7.40%, up from 7.28% a week earlier and 6.30% a year earlier; the 15-year rate averaged 6.73%. The survey averages rates on applications lenders submit to Freddie Mac in a Thursday-through-Wednesday week. [2] Reuters described 7.4% as a nearly three-year high and said high rates are keeping many homeowners in their existing loans rather than refinancing. [1]
What remains uncertain
Reuters says it is an open question how much hedging contributes to the rise in yields, and the hedging evidence is indirect: trading volume, open interest and mortgage spread moves that analysts describe as consistent with hedging. The views quoted are those of the named analysts, some of whom work for firms active in these markets. Treasury yields here are official values through October 9; no October 12 figure was available when this was written. Mortgage rates change weekly.