Why Mortgage Rates Fell Even as the 10-Year Rose

As I’ve mentioned in a few recent posts, even though the Fed has started lowering short rates, the longer end of the curve has remained flat and even ticked up a bit. For example, the 10-year Treasury is up about 10 basis points since the Fed lowered rates. 

Despite this, mortgage rates have actually come down significantly, from around 6.9% in late May on a 30-yr fixed rate to around 6.30% in early October.

What’s driving that? One big factor has been spread tightening in the mortgage market. The spread between the 30-yr fixed mortgage rate and the 10-year Treasury, normally about 1.60%–1.80%, blew out to roughly 3.10% in 2023, pushing mortgage rates painfully higher. More recently, that spread has narrowed to about 2.15%. If spreads were still as wide as they were at their 2023 peak, today’s mortgage rates would be close to a full percentage point higher.

Why are spreads tighter now? Mortgage-backed securities (MBS) markets have found better footing. Demand has improved, net supply is lower because new originations have slowed, and overall credit risk appetite is healthier than it was a year ago. There’s also some expectation that the Fed might slow or pause its MBS runoff, which supports prices. All of this helps pull MBS yields closer to Treasuries with tightening spreads.

For banks and credit unions, this doesn’t change the economics of loans already on the books as those are contractually priced. But it does impact assumption for new volume production and replacement of loans that prepay or mature. If your ALM or pricing models still assume the wide spreads of 2023, your new-volume margins and prepayment incentives could be way off.

Bottom line from a modeling perspective: spread assumptions aren’t “set and forget.” Refresh them regularly - I suggest at least quarterly - and more often when markets move for mortgages and all other loan products. Regularly refreshing spreads keeps your ALM models grounded in today’s market and helps you price new business with confidence.