Since the Federal Reserve announced a 50 basis point rate cut on September 18, mortgage rates in the usa have not only failed to fall but have instead risen, surprising many market participants.

From September 17 until now, the 30-year Mortgage-Backed Securities (MBS) yield has surged by 84 to 96 basis points, while mortgage rates have increased by 72 to 89 basis points. Meanwhile, medium- to long-term Treasury yields have only risen by 53 to 67 basis points.

Real estate economist Tom Lawler believes that there are two main reasons leading to the increase in MBS and mortgage rates surpassing the Treasury yields.

First, the implied volatility of usa Treasury options has surged. Following the Federal Reserve rate decision, a series of unexpectedly strong economic data and slightly higher inflation data caught market participants off guard.

Analysis indicates that increased implied volatility implies greater uncertainty in future rate changes. As interest rate volatility rises, borrowers are more likely to choose early repayment (or to refinance at a lower rate when rates drop). This risk causes investors to increase risk premiums when pricing loans to compensate for the losses incurred from borrowers repaying early.

Secondly, this involves the adjustment spread of Mortgage-Backed Securities (MBS) options (OAS, option-adjusted spreads). OAS refers to the difference between MBS yields and risk-free Treasury yields, adjusted to consider the impact of early repayment and other behaviors, reflecting the additional returns investors demand to compensate for MBS risks.

Before the substantial rate cut by the Federal Reserve, OAS was at a relatively low level, typically considered the normal range without Fed intervention. However, after the rate cut, due to higher market expectations of rate volatility, investors face increased borrower early repayment risks, leading to an increase in OAS. Investors require higher yields to offset potential losses.

It is worth noting that Lawler suggests that the 30-year mortgage rates may be reassessed. This is considering the normal yield curve, the normal spread from 10-year Treasury yields to 30-year mortgage rates, and his assessment that the best expected neutral real rate for the usa should be between 1.75% and 2%. He also added:

"Of course, the inflation/inflation expectations need to be included in this range. When the Federal Reserve achieves its 2% inflation target, then the neutral interest rate will be 3.75% to 4%."

Lawler also believes that in the absence of economic recession or crisis, 6% to 7% mortgage rates for 30-year terms may become the new normal.

Editor/ping