Mortgage Hedging Is Adding Pressure to Treasurys, but Analysts Say the Effect Is Fading

Mortgage bond investors have been hedging against rising rates in ways that add selling pressure to U.S. Treasurys, according to a Reuters analysis published Oct. 12. Analysts quoted in the report also said the effect is likely smaller than in past selloffs and may be fading.

Tuesday, Oct. 13, is the first U.S. bond trading session since the Columbus Day market close. At 10:19 a.m. Eastern, market quote data showed the 10-year Treasury yield at about 5.22%, down from a prior close near 5.28%. Intraday quotes change quickly and are not official Treasury figures.

Why this matters: Mortgage rates track mortgage bond prices, not Treasury yields alone. When mortgage bonds sell off more than Treasurys, mortgage rates can rise faster than the 10-year yield. Hedging is one reason that can happen.

Cover: Editorial illustration explaining mortgage convexity hedging. Illustration created for mortgage.news; it does not depict a real person, property, product screen or document.

Convexity hedging in plain English

When rates fall, homeowners refinance and mortgage bonds pay back early. When rates rise, refinancing stops and those bonds are expected to last longer. A longer-lasting bond loses more value if rates rise further.

To offset that added risk, investors sell Treasury futures or enter interest rate swaps that pay a fixed rate. Reuters said that selling can push Treasury yields higher still, which is why traders watch it during selloffs.

Signs of hedging

Reuters cited several data points, each attributed to its source:

• Eris Innovations CEO Mike Riddle said nine very large block trades in CME-listed Eris SOFR swap futures were executed by the first week of October.
• Open interest in those contracts hit a record 866,768 on Sept. 21, according to the Reuters report.
• An Annaly Capital Management note said mortgage bonds underperformed comparable Treasurys by 96 basis points in September, the worst month since March 2023.
• AGNC Investment Corp. said mortgage spreads to Treasurys widened about 13 basis points in September to 125 basis points.

Analysts told Reuters this pattern is consistent with hedging. It does not prove hedging alone caused the move.

Why the effect may be smaller now

Barclays strategist Amrut Nashikkar told Reuters that more mortgages now have no refinance incentive, which makes further selloffs less destabilizing. U.S. Bank's James Wang said Fannie Mae and Freddie Mac hold far smaller portfolios than before 2008, when they were the biggest hedgers. “Monetary policy expectations are the No. 1 driver of the selloff,” Wang said.

Reuters said the 10-year yield has risen about 130 basis points since late February, driven by an oil price spike and expectations of further Federal Reserve rate hikes.

Practical takeaway

Watch both the 10-year yield and the gap between mortgage rates and that yield. A lower 10-year this morning does not guarantee lower rate sheets today, since lenders reprice on mortgage bond prices. Official end-of-day yields are posted on the Treasury website. Borrowers should compare written quotes from more than one lender on the same day.