Possible decrease in spread with the Fed finishing its monetary tightening.

The popular 30-year, fixed mortgage rate is loosely benchmarked to the 10-year Treasury bond. Since the end of the Great Recession, the 30-year, fixed mortgage rate has on average remained 1.7 percentage points (170 basis points) higher than the 10-year Treasury bond yield. The spread in today’s market is closer to 3 percentage points. Many expect that mortgage rates will come down later this year, and that expectation is rooted in the belief that cooling inflation and more certainty about the outlook for monetary policy will result in a narrowing of the spread. However, some of the drivers of the widening of the mortgage rate spread will likely remain sticky, which may prevent mortgage rates from meaningfully declining. The spread between the 30-year, fixed mortgage rate largely reflects the risks associated with investing in mortgage-backed securities (MBS) -- plus the elements of supply and demand. For example, over the course of the pandemic, the Federal Reserve was a large buyer of mortgage-backed securities in the secondary market, generating demand that increased MBS prices and lowered yield for investors – this resulted in lower mortgage rates. Now that the Fed has backed out as a buyer, there is less demand and that has contributed to the reverse – an increase in the spread. It’s possible that the spread will decrease when the Fed finishes its monetary tightening, which could be in the coming months. That would give investors some more certainty. And, if the spread narrows, then mortgage rates could come down even if the benchmark 10-Year Treasury stays the same. But prepayment and duration risk will remain because so many homeowners remain rate-locked into much lower mortgage rates, and it’s less clear when the Fed may start lowering rates again, or what the “just right” federal funds rate level even is for this economy. Additionally, the Fed is unlikely to become a buyer of MBS again anytime soon. As a result of the sticky spread, it’s likely that mortgage rates continue to hover in the 6.5-to-7.5 percent range for the remainder of the year, which means affordability will remain a challenge for many home buyers.