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A Tale of Two Interest Rates

Many people believe that there’s a close link between the 10 year Treasury bond and the mortgage rate. That’s not really true. It used to be true when there were more mortgage refinances but today with higher mortgage rates, no one is refinancing. This is why the 10 year treasury rate is 3.7% and the mortgage rate is 6.2% . There’s no connection. The mortgage bond market is totally separate and dependent on demand for mortgages. The treasury bond market has to do with issues the government releases to raise money for the Treasury.

The Federal Reserve is raising interest rates. These are short term rates. The more the Federal Reserve raises the short term interest rates ironically the more the long-term 10 year Treasury rate goes down because investors are afraid of a recession..

Mortgage rates could remain high for a long time even if Treasury rates came down because during the Pandemic the Federal Reserve made the mistake of buying $2 trillion worth of mortgage bonds and $7 trillion worth of Treasury bonds. The Treasury bonds regularly mature and come off the balance sheet while the mortgage bonds won’t mature for 30 years because nobody’s refinancing. The only choice the Federal Reserve has to get rid of these things is to sell the mortgage bonds and that will drive the rates up for mortgage interest for the next few years. Because the market knows the only way the Federal Reserve can get rid of these things is to sell the mortgage bonds, it is pricing in already the eventual sale of these instruments. So there’s pressure for mortgage rates to go up or remain elevated for the next few years.

The Federal Reserve is actually not legally allowed to own mortgage bonds so at some point the Federal Reserve is going to be forced to sell these things off which also would drive mortgage rates up. The only reason the Federal Reserve was allowed to buy mortgage bonds was because of the emergency of the Pandemic. If the interest rates are high there is less demand for mortgage loans; therefore there’s long-term pressure for the mortgage rates to stay very high.

Currently the Federal Reserve is in a bind because there is no way to get rid of $2 trillion in mortgage bonds. It’ll be 30 years before they mature. What will bring the mortgage rates down would be to lower demand for houses and mortgages which is what chairman Jerome Powell is trying to do.

The Federal Reserve’s policies during the Pandemic have created a two tiered America . 1/2 of America is sitting on a house that’s appreciated 40% in value and they are sitting on a 2% mortgage rate because the Federal Reserve lowered the rate at 2-3% while the other half of America are the renters. The renters are the ones in bad shape because the prices of houses went up so much that the rental payments are higher than mortgage payments. So the renters have not benefited from the appreciation of the home prices.

How to remedy? A proposed idea would be for the Federal Reserve to package the mortgages and sell them to hedge funds and mutual funds. The hedge funds and mutual funds benefit from that because they would have a government guaranteed security that’s paying them 6% for 30 years that would be a very popular instrument.

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