Stop Looking at the Fed Rate | Start Looking at the 10-Year Treasury
By Terry Roberts
The Home Loan Hub
Published 3:30pm CST Dec. 15, 2022
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If you’re in the market to buy a home, whether it’s your first time or last time, you are likely thinking about the mortgage interest rate. Unfortunately, The Board of Governors of the Federal Reserve System (also known as the fed) has made headlines almost constantly over the last couple of years.
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As a home loan lender, I have had hundreds of conversations with clients since the interest rates plummeted to the 2’s just a couple of years ago. One of the most confusing aspects of the rate market is the relationship between the fed rate and mortgage rates.
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High Yields on Treasurys Mean Higher Rates on Mortgages
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It’s a common misunderstanding to assume that if the fed increases the federal funds rate (also known as the fed rate), then that means the mortgage rates will increase as well. That’s not necessarily the case. These are two different rates.
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What is the Fed Rate?
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The fed rate is the federal funds rate. This is the interest that banks in the U.S. pays each other to either borrow or loan money overnight. U.S. banks are required to always have a minimum amount of money in reserves. Some U.S. banks who have excess reserves have the opportunity to lend some of those reserves to other banks that need additional money to meet that minimum amount of required reserves. The fed rate is the interest rate that these banks charge other banks to lend this money. When it gets more expensive for banks to borrower money, then it gets more expensive for consumers to borrow money. Because of this, consumer loans such as auto loans, credit cards, and unsecured (cash) loans will become more expensive to borrow, resulting in higher consumer loan interest rates. This is why auto loan and credit card interest rates increase when the fed rate increases. Not so much with mortgage rates.
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What is a 10-year Treasury?
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A treasury bond (T-bond) is a government debt security that is issued by the U.S. government that has a maturity range between 10 and 30 years. A Treasury yield refers to the annual interest rate the U.S. government pays on the money it borrowers in order to raise capital by selling Treasury bonds. These are also known as Treasury bills or Treasury notes, but the terminology will depend on the amount of time it takes for maturity. The red line below indicates the fluctuation of the 10-year Treasury yield from January 2022 through December 15, 2022. The blue line indicates the average 30 year fixed mortgage rate during the same time-frame.
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Great! So, What’s the Point?
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The whole motivating factor behind Treasury yields is demand. If there is a high demand for Treasury bonds, then that will result in a lower yield. If there is a low demand for treasury bonds, then that will result in a higher bond yield.
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Investors pay close attention to bond yields. Here’s why: investors intend to maximize the return on their investments. Treasury bonds will not typically provide a greater return on investment than other investment options such as real estate or stocks. However, if investor demand in other options such as real estate or stocks is low, it’s because investors have lower confidence in those real estate or stock options.
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The Treasury sells bonds at auction. When investors decide that their best option is Treasury bonds (high demand for Treasury bonds), then Treasury yields will decrease. This is due to low confidence in the economic outlook, i.e. lower return on real estate and stock investments and mortgage rates will decrease as well. When there is low demand for Treasury bonds, then Treasury yields will increase. As Treasury yields increase, mortgage rates will likely increase as well.
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If Treasury yields trend up, then mortgage rates will trend up.
If Treasury yields trend down, then mortgage rates will trend down.
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The Point is This:
Stop looking at the fed rate if you’re trying to figure out which way mortgage rates are going. Start looking at the 10-year Treasury yields. If 10-year Treasury yields are trending up, then it is very likely that mortgage rates will begin (or already are) trending up as well.
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Terry Roberts is a U.S. Marine Corps Veteran and specializes in residential mortgages, including new construction, conventional, FHA, and VA home loans. He has helped more than 10,000 clients start the homebuying process across America.
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