30 Year Treasury Bonds - the Pin on the Horizon
Chuck Ponzi January 17th, 2006
The US Treasury announced that they will be offering 30 year bonds for the first time in 5 years.
You might ask, what does this have to do with real estate in Southern California. Maybe more than you think.
Normal investors that have a 30 year investmen plan should really be seeking a higher rate of return than the measly 4.5% that they are likely to generate. Where would demand for such a product come from?
In a group: pension plans, annuities plans, and insurance companies. Perhaps even foreign governments?
These are some of the largest buyers of asset-backed securities. If demand for 10 year bonds weakened in favor of 30 year bonds, we could very well see markedly higher interest rates for mortgages.
How, you ask? Well, many mortgages are aggregated and packaged as 10-year bond offerings on the MBS (Mortgage Backed Securities) market. They typically have a 10 year maturity because the average mortgage tends to be redeemed at that point, not 30 years. So, the reduced demand on MBS’s could rais interest rates noticeably.
Some people might be asking at this point, “Is this for real, or just another hoax?” Well, it worked the same way in reverse. When the 30 year was discontinued, demand for the 10 year jumped substantially and they yields (along with mortgage rates) went in the crapper.
Since mortgage rates are already on the rise because of inflation and the potential weakness of the dollar from Euro strength and Yuan appreciation, you could be seeing some big changes in mortgage rates over the next year.
maybe and maybe not
the mortgage world has changed a lot, and for better or worse rates are based on costs of funds and operating revenue for the lenders, we already saw this over the last year as fed funds rates rose but mortgage rates held steady or increased by a markedly smaller rate
new mortgages are going to be priced (set at a rate) independent of t-bill and bond rates as well as independent of the federal funds rate
that said, people with existing ARMs based on the 10-year note may have some problems but they will have time to adjust and seek refinance options
this isn’t to say the market isn’t overpriced and frothy but don’t assume big changes due to so changes in the treasury yield curve
Interesting point Chris,
if you operate on the logic that supply is quickly contracted, and demand remains strong, you would expect yields to rise along with rates, not stay steady.
Sorry to be a pest, but I really must understand what you mean by “cost of funds” and “operating revenue”. I was under the impression that most mortgages were sold in the open market and most “mortgage” companies today were either mortgage brokerages or management companies who are administrators for payment collection, managing a portfolio that is “owned” by external investors and traded on open exchanges. Please correct my thinking on this if I am incorrect.
The supply portion of the equation (in the open market scenario) depends on the bond market (based on the MBS bond it gets packaged to). It has been opined that the largest buyers of these are:
1. Pension Funds
2. Insurance Companies (for annuities)
3. Mutual Funds and other fixed income funds
4. Foreign Governments
Not sure if that’s the order of them, but for many of these groups, their investment horizon is quite long, and obviously there is a unmet need there determined by the Treasury.
I’m not confident that short-term holders of bonds could or would influence the yields for 4 years straight that we have seen.
I think it might be a strech, but this might actually take some pressure off of the inverted yield curve by increasing yields on the 10 year. That would still mean that we would be inverted on the long-end, but this is much more livable than a short-term invert. We will see if that happens, but I’m not hopeful.
I disagree that new mortgages will be priced independent of t-bill and bond rates. Investment-grade MBS’s behave quite similarly to bonds and t-bills, and their yields move in similar lockstep. The conundrum has been the yield spreads across investment types that typically had higher risk premiums. Either investors collectively know something that the Fed does not about its own policy and risk premiums, or money supply is having a downward pressure on yields because there is too much liquidity chasing too few returns.
BTW, when you say the market is overpriced and frothy, are you referring to the RE market or the bond market. While the same could be said about both, it seems clear that they are symptomatic of a liquidity bubble.
Noone hopes for a bond crisis or a general liquidity trap, so we are all hoping that yields increase. Credit expansion has been fueling the bubble, so a contraction is in order. The easiest way to do that is slowly increasing interest rates… but this has to be connected to consumer demand somehow or we find ourselves with a credit event and bankrupt banks and deflation (I consider this highly unlikely knowing our inflationary policy).
well some basic differences in our assumptions:
30 year treasury bonds are being offered because of the size of the federal deficit not because of a demand from the bond market
yes most mortgages are resold but they are not all packaged and sold as MBS, many are simply sold and held by investment groups, private investors, and firms in other portions of the finance field that want to diversify
the real estate market is frothy, the bond market i would say is priced correctly given uncertainty in oil markets and the relative unattractive level of the stock market
cost of funds refers to just that, because the days of firms borrowing from the fed bank and lending that money out are over costs of funds refers to the ability of a mortgage firm to either package and resale a mortgage, to hold the mortgage so their cost of the origional funds plus operating costs to administer the loan, mortgage firms (look at ditech for one example) now raise a large amount of their money on wall street, from venture capitol and private placement investors - all sources the yield a cost of funds divergent from a federal bond market curve
this is not to say changes in the t-bond curve won’t have an impact, but i would predict that impact to be very small
when i said the only thing that would make a large impact would be a change in supply - either fewer loans avaliable or many more homes avaliable
30 year treasury bonds are being offered because of the size of the federal deficit not because of a demand from the bond market.
That’s exactly right. And that’s exactly why our blog host is right. When the government rediscovers the need to borrow via 30-year bonds, it’s no different from a would be homeowner who opts for a 40 year mortgage — it’s a sign of weakening credit or ability to borrow. And the flip side way to describe that is that lenders are demanding higher interest rates. And what all of this points to is pressure on mortgage rates. They’re going to continue to rise for a while.
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————- SNIP (email text end) —————
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————- SNIP (email text end) —————