Market Realist – Phalguni Soni
The period from September 2012 to the present has been unconventional for U.S. fixed income markets. The unprecedented scale of monthly bond purchases ($85 billion per month initially), longer-term US Treasuries, and agency-backed securities by the U.S. Federal Reserve, and the subsequent curtailment of the same (reduced by $10 billion each in December 2013, January 2014, and March 2014, to $55 billion currently), has produced some unexpected reactions in bond markets.
Correlations between mortgage rates and Treasury yields:
The historical correlation between the percentage change in weekly market yields on 30-year U.S. Treasury securities (TLT) and the percentage change in weekly interest rates for 30-year conventional mortgages between January 2007 and mid-March 2014 was computed at 0.51. The correlation between the percentage change in market yields for ten-year Treasury securities and the percentage change in interest rates for 30-year conventional mortgages for the same period came in even higher, at 0.62. Changes in the yield on ten-year Treasuries (IEF) correlate even more with changes in mortgage rates, as the effective duration of a 30-year mortgage is considerably lower and is nearer the ten-year maturity of the Treasury bond than the 30-year bond. This is because of the principal prepayment option present in most mortgages (MBB), which mortgage holders frequently exercise when rates are falling.
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