Treasury Yields Hit Record Lows, But Will it Last?

Weaker-than-expected construction spending and quickly falling manufacturing activity helped send stocks sharply lower Monday morning, fueling a continued rise in demand for U.S. Treasuries — and likely pressure from secondary mortgage markets also contributed the extremely bullish bond sentiment as well, sources told HousingWire Monday morning. Call it the two-fer Treasury rally: safe-haven buying combined with a good old-fashioned convexity event, thanks to Fed intervention in U.S. mortgage markets. Manufacturing activity declined at the fastest pace in 27 years during Nov., with a key index falling to 36.2 percent from 38.9 percent in Oct. The Institute for Supply Management‘s index reached the lowest level since 1982, and fell significantly further than the 37 percent most economists were expecting to see, according to a MarketWatch bulletin. Index values below 50 percent indicate contracting manufacturing activity. Construction spending also posted a larger-than-expected decline in October, according to data released Monday morning by the Commerce Dept. — total construction spending dropped by 1.2 percent in October, led by ongoing weakness in home building activity. Housing construction fell by 3.5 percent in October to a seasonally-adjusted annual rate of $338.8 billion, following a 0.5 percent drop in September; private residential construction has fallen every month but two in the past 2 1/2 years. Spending on private construction was at a seasonally-adjusted annual rate of $756.5 billion, 2.0 percent below a revised Sept. estimate of $771.9 billion, the Commerce Dept. said. Nonresidential construction — which has been a strong point throughout the credit mess — also began to show signs of weakness in Oct., posting a seasonally-adjusted annual rate of $417.7 billion in October, 0.7 percent below Sept.’s estimates. See the full construction spending report. As a result, the Dow slid to 8,466.88, a 362.16 point drop, in early trading Monday. Every mortgage and housing-industry stock tracked by HousingWire had fallen into red territory, including Goldman Sachs Group, Inc. (GS), which was at $70.52, down 10.72 percent when this story was published. Investors flocked to the relative safety of Treasury notes: the yields on two-, 10-, and 30-year securities fell to record lows, Bloomberg News reported. Bond yields move conversely with prices. The 10-year note yield fell to 2.81 percent at 10:38 am EST, Bloomberg data showed; the two-year note had declined to 0.93 percent, while the 30-year bond yield had dropped 13 basis points to a record 3.28 percent. Mortgages pitch in, too Further driving up demand for Treasuries, and helping yields reach record levels, was also a classic “convexity bid” by secondary mortgage market participants, according to HousingWire’s sources. The Federal Reserve said on Nov. 25 that it would initiate a program to purchase up to $100 billion GSE direct obligations and $500 billion MBS backed by Fannie Mae (FNM), Freddie Mac (FRE) and Ginnie Mae. As a result, conforming mortgage rates dropped sharply in the short run from 6.0 percent to 5.5 percent, and set off a mini-refi wave. While rates have since increased somewhat, the spike in repayments essentially has the effect for secondary mortgage market participants of reducing bond duration, as homeowners refinance out of their existing higher-rate mortgages. As a result, investors tend to allocate purchases towards longer-dated Treasuries, in a bid to to increase portfolio duration. (If you’re looking to learn more about duration and convexity, check this out.) All of the above is a technical way of saying that the Fed’s move to bolster RMBS markets, timed with weak economic data, has made Treasuries look awfully attractive to most investors. The combined result here is lower mortgage rates for borrowers. But analysts at UBS Investment Research said Monday that such a bullish sentiment isn’t likely to last, citing a push to lower long-term rates as the key driver behind recent demand for Treasury securities. “We have growing concerns … that the crowd in Treasuries is getting too thick,” the analysts wrote in a research note. “We believe that we’re in the last two months of the bull run.” Mortgage rates historically tend to move in tandem with 10-year Treasury yields, although spreads in this area have been well outside historical averages for most of this year. While the Fed’s decision to sop up net agency MBS issuance over the next few quarters has largely led most industry analysts to expect spreads to tighten closer to historical averages, an end to the bull-run on Treasuries — when it arrives — would likely end up boosting mortgage rates from their current levels anyway, sources suggested. And, as we’ve suggested numerous times in the past, rates are by far the least of most borrowers’ concerns. Qualifying for a mortgage is likely to be a much tougher task than squeezing into a 5.5 or 6.0 percent mortgage, for most borrowers — and especially for those troubled borrowers looking to avoid a possible foreclosure. Write to Paul Jackson at [email protected].