If you’re a prospective homebuyer, crazy inflation and rising interest rates are no strangers to you. To be sure, 2022 has seen some wild and unprecedented volatility in almost all markets. But there’s yet another crazy market move underway that flies under the radar most of the time. Do you know what’s going on between the 10-year treasury bond yield (the benchmark for mortgage interest rates) and the 30-year average mortgage rate? Well, this “spread” is widening to levels not seen since the GFC (December 2008) and back in mid-1980’s (when inflation was in double digit territory). History shows this spread cannot be maintained. Let’s take a closer look at this Bond Yield/Mortgage Rate spread shall we?
The 10-year treasury bond yield has been the benchmark for 30-year mortgage rates for quite some time. When bond yields rise, so do mortgage rates. When bond yields fall, mortgage rates tick lower. This correlation has been in effect for decades. However, sometimes these two markets don’t move in lock step and the difference in the resulting gap is called “the spread.” In the following chart, you can see how the spread has widened significantly over the last year as the Federal Reserve embarked on their series of aggressive interest rate hikes.
History shows us the long-term average spread between the 10-year bond yield and the 30-year mortgage rate is approximately 1.75%. For example, if the 10-year yield is 4%, the corresponding 30-year mortgage rate should be around 5.75%, but that’s not the case today or over the last few months. In fact, just last month (late October) the spread was 3%, which translated to a 30-year mortgage rate above 7%! We’ve only seen the spread this wide during the great financial crisis (2008) and back in the 1980’s when inflation was in double digits. That spread did not stay elevated for long, and each time it reverted back towards the 1.75% average.
See chart below:
So what does it alll mean? In my opinion, mortgage rates have overshot to the upside and should move lower to better reflect the long-term historical average spread of 1.75%. In other words, if you look at today’s (11/29/2022) 10-year bond yield of 3.71% and add the average spread of 1.75%, 30-year mortgage rates “should be” approximately 5.50%. Unfortunately we are not there yet, as the average 30-year mortgage rate is closer to 6.5% presently. But if history repeats itself we should see the spread narrow, and all else remaining equal, mortgage interest rates should move lower.
