If you’ve been watching the news you’ve seen chatter of the Fed cutting rates or interest rates falling because of the Trump tariff news. And volatile it has been.
The 10-year Treasury has whipped around since October of last year (which feels like a decade ago), running up to 4.8% around the end of 2024 before crashing lower to 4 percent, only to snap back 30 basis points higher this week.
Everyone Kind Of Knows Treasury Rates Impact Mortgage Rates, And They’re Right
If you have been Googling "mortgage rates" lately and wondering why they have not gone down, you are not crazy.
Yes, the headlines might talk about "falling rates." Yes, the Federal Reserve might be hinting at cuts. But when you pull up a real mortgage quote from a lender, it still feels like the same bad joke: 6.5 percent, 7 percent, maybe even worse. Sure, it has dropped a little. But should it not be lower?
Here is why most people get tripped up. Your mortgage rate is not tied to just one thing. It is a cocktail of market dynamics most never see. And right now, a lot of those hidden gears are grinding against you.
How Mortgage Rates Really Get Made, Inside the Sausage Factory
The first thing to understand is that mortgage rates are anchored to Treasury yields, particularly the 10-year Treasury. Think of the 10-year as the "risk-free" baseline for long-term borrowing.
But your mortgage is not risk-free. You can refinance, prepay, move, or default. So lenders cannot simply lend at Treasury rates. They have to add layers of risk premium and operational costs.
This happens in two major steps:
Step #1 MBS Spread:
Mortgages are bundled into Mortgage-Backed Securities (MBS) and sold to investors. Yes, just like in The Big Short. MBS carry prepayment risk, credit risk (for non-agency loans), and liquidity risk. Investors demand a higher yield on MBS compared to Treasuries to compensate for these risks.
This difference between the MBS yield and a comparable Treasury or swap rate is called the MBS spread.
Step #2 Primary/Secondary Spread:
After lenders originate loans, they usually sell them into the secondary market, either directly or through securitization. Offering loans comes with real costs such as underwriting, servicing, pipeline hedging, and capital requirements. Lenders also need to earn a profit.
The difference between mortgage rates offered to consumers (the "primary" market) and the yields investors are willing to pay in the secondary market is called the Primary/Secondary Spread.
Put it all together:
Mortgage Rate ≈ MBS Yield + Primary/Secondary Spread, where MBS Yield ≈ Treasury Yield + MBS Spread.
In short, your mortgage rate is based on Treasury yields, plus the extra compensation investors require for holding mortgage bonds, plus the costs and margins lenders build into retail rates. These are constantly moving.
Whether people like it or not, investor demand for MBS impacts your mortgage rate. Always has, always will. And with the Fed NOT buying right now and big banks buying less than they historically do, there’s a bit of a vacuum in demand. And volatility also stings if you’re looking for lower rates.
This Graph Matters
It is the mortgage spread I referenced above. Technically, it is the spread between the Current Coupon MBS and a blend of the 7-year and 10-year Treasury yields (for the nerds keeping score). If it’s wide, it will impact your mortgage rate and make it higher than rates would otherwise imply. Or than you’d otherwise want.
What's Messing with Spreads Right Now
Even when Treasury yields fall (good news), if spreads widen (bad news), your mortgage rate might not move much which we now know.
And recently, spreads have been widening, not tightening. It is mostly about market mechanics, not economic fundamentals.
Reason #1 Forced Selling:
Mortgage REITs like AGNC and NLY, and MBS-heavy ETFs like MBB and VMBS, have faced redemption requests from investors. To raise cash, these funds had to sell MBS into a relatively illiquid market.
Reason #2 Liquidity Stress:
When too many sellers flood the market and buyers hesitate, prices drop, MBS yields rise, and spreads widen. Basic supply and demand under stress.
Reason #3 Convexity Hedging:
Some institutions that hedge MBS exposure are forced to sell Treasuries or MBS as rates move, which amplifies volatility.
Heavy selling pressure drives MBS prices lower relative to Treasuries, which increases the MBS spread. At the same time, mortgage originators, dealing with funding constraints and uncertain loan sale execution, widen their primary/secondary spreads to protect margins. One big butterly effect in action.
And the past few days, AGNC and other bigger mortgage buyers were hit with the Cramer “SELL SELL SELL” yesterday which dumped MBS onto the market all at once. And with limited buyers that created the spread craziness.
What Would Actually Lower Your Mortgage Rate
If you want mortgage rates to come down, here's what needs to happen:
Stabilized Treasury Yields: Less volatility reduces defensive hedging and reassures buyers.
Tighter MBS Spreads: Real money investors like banks, insurance companies, and pensions need to step into the MBS market. The Fed also buys mortgages but is reinvesting less and less.
Reduced Forced Selling: Mortgage REITs, ETFs, and levered vehicles need to stabilize. People need to stop selling.
Normalization of Primary/Secondary Spreads: As secondary market liquidity improves, lenders can tighten the spread they charge over MBS yields.
Potential Fed Assistance: A well-communicated Fed easing cycle can indirectly support liquidity, without causing panic. This would look something like a new “Quantitative Easing” which is code for buy a bunch of MBS.
Less Volatility Equals More Stability
This chart of Treasury volatility over the past year says it all. When volatility drops, spreads often tighten, and mortgage rates can finally start falling. But that volatility is high today and so mortgage rates stay higher than we’d want.
We want, low volatility, lower rates, more MBS demand. Simple. Then we get our sub 5% mortgage rates.
When to Google Mortgage Rates For Your Sub 5% Mortgage?
In short, your mortgage rate will fall when the mortgage market, from Treasuries to MBS to lender pricing desks, calms down and finds two-way flow again.
Until then, what you are seeing is not broken. It is just how a stressed, rate-sensitive machine behaves.
Now you know. And if you are still holding out for that magical 5 percent mortgage rate, maybe keep that champagne on ice a little longer.
Until next time,
Victaurs
PS: This Also Matters If You Invest in Mortgage-Linked Stocks
RKT:
Rocket Companies makes a lot of money on mortgage refinancing. The stock tends to go up when people expect refis to rise, and down when they do not. Driven mostly by rates, but increasingly by spreads too. Wide spreads will keep it from rallying, tighter spreads plus lower rates will push it higher.
AGNC:
Agency REITs like AGNC cannot hedge spread risk effectively. If you believe mortgage spreads will tighten (I am not making that call here), agency REITs could rally meaningfully.
Good write-up. I think marginal demand for MBS will remain low for the foreseeable future. The Fed is well below it's QT cap on reinvesting monthly cashflows so the largest price-insensitive buyer is sidelined. Also given what their buying did to spike RE prices I'm not sure they'll want to get into the MBS game again.
A lot of banks also got burned by low-coupon 30yrs during COVID and are sitting on unrealized losses on what are now 8-9yr WAL bonds...with the trillionaire banks forced to include AOCI marks in capital and whispers of smaller Cat 3/4 banks potentially needing to phase-in AOCI to capital they won't want to hold massive amounts of negative convexity. Yes, you can pay on swaps vs them but it's more of a pain to ensure hedge accounting on MBS vs bullet securities like USTs or Agency CMBS.