Recent events have prompted significant volatility in the mortgage market. The 10-year U.S. Treasury rate (10UST) dropped to all-time lows below 1% and significant selling was seen in risk markets. Multi-point swings in pricing have occurred over very short periods of time during March.
What makes this month unique is the massive move between the primary and secondary mortgage rates, known as the primary-secondary spread. This spread represents the difference between mortgage rates offered to borrowers and yields on MBS bonds. Figure 1 shows this spread, and the volatility is clear. Increases in the spread often are related to capacity constraints in the mortgage origination process. For example, in the face of falling U.S. Treasury rates and a deluge of mortgage refinance applications, rates posted online from various lenders showed increases in mortgage rates, particularly for refinance loans. When spreads on loans widen relative to MBS, it leads to underperformance on a net hedged basis.
Figure 1: Primary/Secondary Spread
Several factors have led to the spread widening event on loan pricing, leading to loan under-performance:
- Bid/ask spreads wider (liquidity event)
- Pay-ups collapsing (prepayment event)
- Risk appetite in the marketplace
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