June 17 (Bloomberg) -- Yields on Fannie Mae and Freddie Mac mortgage securities declined for a fifth day, tracking a drop in rates on benchmark U.S. Treasuries and suggesting further declines in borrowing costs for new home loans.
Yields on Washington-based Fannie Mae’s current-coupon 30- year fixed-rate mortgage bonds fell 0.06 percentage point to 4.52 percent as of 10:55 a.m. in New York, the lowest since May 29, according to data compiled by Bloomberg.
Treasuries and so-called agency mortgage bonds rallied after a government report showed the cost of living rose less than forecast in May. The mortgage-bond yields are down from 5.07 percent on June 10, the highest level since the Federal Reserve announced plans to buy home-loan bonds in November.
“There is a large feeling that we hit the highs in yield last week because of supply,” said Adam Brown, a managing director and Treasury trader at primary dealer Barclays Capital Inc. in New York, referring to government notes. “The absence of supply has allowed the market to rally back to what people think are fair levels.”
The difference between yields on the Fannie Mae bonds and 10-year Treasuries fell 0.02 percentage point today to 0.9 percentage point, Bloomberg data show. The gap, which grew to as much as 2.38 percentage points last year, contracted to 0.7 percentage point on May 22, the lowest since 1992.
The mortgage securities had soared from 3.94 percent on May 20, helping drive the average rate on a typical 30-year loan to 5.59 percent in the week ended June 11, up from 4.82 percent for the week ended May 21 and a record low of 4.78 percent April 30, according to McLean, Virginia-based Freddie Mac.
‘Tail of the Dog’
The rate fell to 5.53 percent as of early yesterday, from a six-month high of 5.74 percent on June 10, according to Bankrate.com. Yield spreads over 10-year government notes on the mortgage bonds have narrowed from a two-month wide of 1.14 percentage point on June 8.
Hedging by mortgage-bond holders and servicers had driven some of the recent increase in Treasury yields and spreads on home-loan bonds, a dynamic that is now being reversed.
“A lot of the movements in Treasuries have come because of supply and demand from other markets, namely mortgages and swaps,” Brown said. “The Treasury market has been the tail of the dog and not the dog itself.”
As rates increase, the expected average lives of mortgage bonds and loan-servicing contracts extend as potential refinancing drops, leaving holders with portfolios of longer- than-anticipated durations. Investors then may seek to pare durations by selling longer-dated Treasury securities, mortgage bonds and interest-rate swaps, sending yields even higher. The opposite happens when rates decline.
Bond Duration
The duration of the agency mortgage-bond market extended to the equivalent of about $1.9 trillion of 10-year U.S. Treasuries as of yesterday, almost double the year-end level of about $1 trillion, Chris Ahrens, Jeana Curro and Eric Liverance, UBS AG strategists in New York, wrote in report today.
Duration is an estimate of how much the price of a bond will change when interest rates rise or fall. The duration of fixed-rate agency-mortgage bonds fell to 3.18 years as of yesterday, down from a seven-month high of 3.85 years on June 10, according to Barclays Capital index data.
“For those who believe rates will go down, hedge ratios will certainly shrink which will result in an immediate contraction as borrowers refinance,” the UBS analysts wrote. “We do not expect to see 4.875 percent mortgage rates anytime soon and consequently anticipate the market will stay extended for some time.”
Consumer Prices
Yields on agency mortgage bonds are guiding rates on almost all new U.S. home lending following the collapse of the non- agency market in 2007 and a retreat by banks. The almost $5 trillion market includes securities guaranteed by government- controlled Fannie Mae and Freddie Mac and bonds of U.S.-insured, low-down-payment loans backed by federal agency Ginnie Mae.
The consumer price index increased 0.1 percent in May after no change a month earlier, capping the biggest 12-month decline since 1950, the Labor Department said today in Washington. Economists forecast consumer prices rose 0.3 percent, according to the median of 75 projections in a Bloomberg News survey.
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