US Treasury yield surge fuels mortgage hedging and bond-market pressure

what happened

A sharp increase in long-term US Treasury yields has prompted additional hedging by mortgage investors, adding selling pressure to an already strained bond market. Since late February, the 10-year Treasury yield has risen about 130 basis points and the 30-year yield 100 basis points. The move reflects a war-driven oil-price spike and expectations of multiple Federal Reserve rate hikes over the next 12 months. The 30-year mortgage rate has climbed to a nearly three-year high of 7.4%.

Higher rates extend the expected life of mortgage-backed securities, making them more exposed to further yield moves. Investors typically respond by selling Treasury futures or entering interest-rate swaps that exchange a fixed coupon for a floating rate. By the first week of October, nine megablock trades had been completed in CME-listed Eris SOFR swap futures, each representing at least $200,000 of exposure to a one-basis-point rate move. Open interest reached a record 866,768 contracts on September 21, more than double the previous year’s level.

Analysts said the effect of these flows may diminish as yields rise because more mortgages become out of the money, removing borrowers’ incentive to refinance. In September, MBS underperformed Treasuries with comparable duration by 96 basis points, while mortgage spreads widened by about 13 basis points to 125 basis points. James Wang of US Bank said monetary-policy expectations remain the main driver of the selloff.

why it matters

For markets, mortgage convexity hedging can temporarily intensify pressure on Treasuries, but its influence is likely smaller than before: the mortgage portfolios of Fannie Mae and Freddie Mac have contracted significantly since the 2008 financial crisis.

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