Is this spread heading for what happened in the 1970s and 1980s when the Fed fought explosive inflation?
By Wolf Richter of WOLF STREET.
The 30-year average fixed mortgage rate tracks the Treasury yield for 10 years and runs almost in parallel, but higher. An average 30-year mortgage will be repaid in less than 10 years, either by selling the home or by refi, so track the 10-year yield. But they didn’t move in the lock step, the difference between the two (spreads) is widening sharply, and mortgage rates are rising much faster than 10-year yields.
The US Treasury’s 10-year yield has skyrocketed since the Federal Reserve’s infamous “pivot” in the fall of 2021. ..
Back in August 2021, the 10-year yield was still around 1.3%. It was 2.34% today, up 1.03 percentage points in 7 months. Over the same period, Freddie Mac’s tracked average 30-year fixed mortgage rate rose 1.55 percentage points from 2.87% to 4.42%.
In the graph above, in the turmoil of March 2020, the Fed announced a huge quantitative easing program that would cut the policy rate close to 0% and plunge the Treasury yield (green line) for 10 years. It shows what happened at times. A systematic decline that continued until December 2020.
Mortgage rates began to fall in late November 2018, and Powell was hit by Trump every day, acknowledging that the Fed would soon stop tightening.
At that time, inflation was below the Fed’s target, and the Fed was raising interest rates that were already above the CPI, lowering its balance sheet at a monthly interest rate of about $ 50 billion (QT). The homes were hit, the stock plunged, and Trump, who took ownership of the Dow, had it.
The fact that 10-year yields plummeted in March 2020 while mortgage rates were slowly declining has blown the spread between the two. It peaked at the end of April with 2.73 percentage points.
The 30-year average fixed mortgage rate continued to decline until it reached a historic low of 2.66% in December 2020.
But four months before mortgage rates began to rise, the 10-year Treasury yield began to rise, bouncing back to a record low of 0.55% in August, narrowing the spread between the two. By December 2020, when mortgage rates reached their lowest levels, the Treasury yield for 10 years had risen to 0.9%. And spreads continued to narrow until 2021.
Part of the very low factor in 2021 mortgage rates was the narrow spread between 10-year Treasury yields and 30-year mortgage rates. At that time, it was performed in the range of about 1.3 percentage points to 1.6 percentage points.
However, in January 2022, spreads began to widen suddenly, with mortgage yields rising much faster than Treasury yields. As of the latest weekly mortgage rates, spreads reached 1.81 percentage points after reaching 2.09 percentage points in early March. Notice the increase in spread volatility.
The long-term pattern shows how wide the spread is. The significant expansion between March 2020 and the financial crisis was due to the Fed’s aggressive depreciation of government bond yields while mortgage rates were delayed.
However, during the mid-1970s and mid-1980s, the Fed aggressively boosted government bond yields and fought the market with significant rate hikes. And the 1980 mortgage rate was higher than the Treasury’s yield for 10 years as lenders were trying to deal with inflation, as it is today. Eventually, the Treasury caught up, followed by a significant rate cut, followed by a further significant rate hike, followed by a significant rate cut, spreads exploding, and contracting with significant volatility.
The current situation (the incredibly soaring inflation that the FRB is lagging behind and intensifying) is much closer to the 1970s and 1980s scenarios than the financial crisis and the March 2020 crisis. Spreads widened as the Fed pushed down Treasury yields between the latter two, while mortgage rates were lagging. Spreads are widening as mortgage rates are now ahead and rising faster than 10-year yields. Spreads are very volatile and can be very wide over certain periods. During these periods, mortgage yields can significantly exceed Treasury yields before mortgage yields catch up or recede.
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