Benchmark for Mortgage Rates

The 10-year Treasury bond serves as a benchmark for 30-year fixed mortgage rates because both are long-term financial instruments. While mortgages typically have longer durations, lenders look at the 10-year yield to price mortgage rates since most borrowers either sell or refinance within 7-10 years.

Yield Movements and Mortgage Rates Correlation

When the 10-year Treasury yield increases, mortgage rates usually rise, and when it falls, mortgage rates tend to drop. This is because both Treasury yields and mortgage rates reflect the cost of borrowing money. 

Example: If the 10-year yield drops to 4%, lenders might lower mortgage rates to remain competitive.

Risk Premium

Mortgage rates are usually higher than Treasury yields to account for the extra risk. Unlike government bonds, which are considered virtually risk-free, mortgages come with default risks. Therefore, mortgage rates include a **spread** over Treasury yields to compensate lenders for this additional risk.

Market Sentiment and Economic Conditions

Mortgage rates and Treasury yields are influenced by similar factors:

• Inflation expectations: Higher inflation leads to higher yields and mortgage rates.
• Federal Reserve policy: The Fed’s interest rate decisions indirectly affect yields and mortgage rates.
• Investor sentiment: When investors feel uncertain (like during a recession), they move money into safer assets, lowering the 10-year yield and, in turn, mortgage rates.

Short-Term Disconnects

While mortgage rates generally follow the 10-year yield, they don’t always move in perfect sync. Events like major Fed announcements, disruptions in the mortgage-backed securities market, or lender-specific factors (e.g., tightening underwriting) can create short-term disconnects between the two.

Summary

The 10-year Treasury bond yield plays a crucial role in determining mortgage rates because of its influence on lenders’ borrowing costs and market expectations. When the 10-year yield rises, mortgage rates typically follow, and when it falls, borrowing becomes cheaper for homeowners.