Mortgage Hedging Sputters, Sapping Energy Behind Treasuries (Fed Tapped Out)

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by confoundedinterest

I had to read this Bloomberg headline several times: “Locust Swarms Ravaging East Africa Are the Size of Cities”

Are the swarms the size of cities or the locusts? If so, those are some pretty big locusts!

But on to Treasury / MBS news.

(Bloomberg) — The mortgage market helped fuel U.S. Treasury yields as they rocketed toward historic lows in 2019. Don’t expect a repeat in 2020 because that propellant appears to be tapped out.

Homeowners refinanced loans in droves last year as they sought to lock in lower rates. As the original loans disappeared, investors in mortgage-backed securities bought swaps to get their newly out-of-whack portfolios back in order. Such convexity hedging tends to drive Treasury yields down. That dynamic was especially prominent in March 2019 as rates on 10-year notes sank 31 basis points after a surprise Federal Reserve policy shift.


Today, the relationship appears to have weakened. A Bloomberg Barclays index of MBS portfolio duration has fallen since the beginning of this year, but longer-dated swap spreads have held steady. This decoupling is evidence that hedging flows are now not likely to crater yields. The index closed down at 2.65 on Tuesday, a third consecutive daily drop.


So, The Fed seems tapped out.


And is having trouble making markets dance.





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