Introduction

I have heard it over and over; people in the financial media presenting information on the bond markets continually make erroneous assumptions about the relationship of mortgage interest rates with US Treasury Bond and Note prices. This happens because these financial reporters may understand the bond markets in general but they are not mortgage experts and do not fully understand how mortgage interest rates are determined. For example, the bond market reporters mistakenly tie mortgage rates to the performance of the US 10-year Treasury Note on a routine basis. You see this happen all the time. In reality, mortgage interest rates and the intra-day re-pricing that occur are determined from the performance of mortgage-backed securities (MBS or mortgage bonds), not US 10-year Treasury Notes.

Performance Comparisons

The table below illustrates data for the month of May 2003. During the 21 trading days in May, the two securities moved in the same direction 18 times but actually moved in the opposite direction three times. If you were watching the US Treasury notes to determine the way mortgage pricing would respond, you would have had a couple of pretty big misses on some of those days (see chart below). Moreover, on the 18 days when they did move in a similar direction, the relative change was close on only 6 of the 18 dates. So the two securities behaved closely on only 6 of a total of 21 trading days (just 28%). The relative change between the two was never exact! On 12 of the 18 days when the two instruments moved in a like direction, the difference in the amount of the move was significantly different. This could have caused client confusion, client frustration and poor or incorrect guidance by the originator to his or her customer.

Performance Comparison Chart Date US 10-yr note $ Change % Change Direction FNMA 5.5% $ Change % Change 30-Apr-03 $100.28 - - - $102.75 - - 1-May-03 $100.25 ($0.03) -0.03% Same $102.72 ($0.03) -0.03% 2-May-03 $99.58 ($0.67) -0.67% Same $102.56 ($0.16) -0.16% 5-May-03 $99.95 $0.37 0.37% Same $102.69 $0.13 0.13% 6-May-03 $100.70 $0.75 0.75% Same $103.09 $0.40 0.39% 7-May-03 $101.61 $0.91 0.90% Same $103.31 $0.22 0.21% 8-May-03 $101.66 $0.05 0.05% Same $103.34 $0.03 0.03% 9-May-03 $99.53 ($2.13) -2.10% Opposite $103.41 $0.07 0.07% 12-May-03 $99.88 $0.35 0.35% Opposite $103.13 ($0.28) -0.27% 13-May-03 $100.14 $0.26 0.26% Same $103.28 $0.15 0.15% 14-May-03 $100.85 $0.71 0.71% Same $103.53 $0.25 0.24% 15-May-03 $100.77 ($0.08) -0.08% Same $103.47 ($0.06) -0.06% 16-May-03 $101.71 $0.94 0.93% Same $103.72 $0.25 0.24% 19-May-03 $101.15 ($0.56) -0.55% Same $103.69 ($0.03) -0.03% 20-May-03 $102.26 $1.11 1.10% Same $103.72 $0.03 0.03% 21-May-03 $101.90 ($0.36) -0.35% Same $103.50 ($0.22) -0.21% 22-May-03 $102.61 $0.71 0.70% Same $103.66 $0.16 0.15% 23-May-03 $102.41 ($0.20) -0.19% Same $103.56 ($0.10) -0.10% 27-May-03 $101.73 ($0.68) -0.66% Same $103.50 ($0.06) -0.06% 28-May-03 $101.63 ($0.10) -0.10% Opposite $103.59 $0.09 0.09% 29-May-03 $102.41 $0.78 0.77% Same $103.75 $0.16 0.15% 30-May-03 $102.11 ($0.30) -0.29% Same $103.66 ($0.09) -0.09%     $1.83 0.02%     $0.91 0.88%

Let’s take a retrospective look at the similarities and differences between two charts, one showing the 10-Year Treasury note and the other the Fannie Mae 30-Year Spot 5.5% Bond. The first chart shows the past performance of the 10-Year Treasury note and the second chart shows the corresponding monthly performance of the Fannie Mae 30-Year Spot 5.5% Bond (FNMA). One similarity that sticks out is the overall upward trend in both charts. One of the differences is the daily volatility characterized by the length of the daily candlesticks – the 10-Year Treasury note tends to be more volatile than the Fannie Mae 30-Year Spot 5.5% Bond.

US 10-yr Note

FNMA 5.5% Mortgage Bond

It is interesting to note that both charts have an overall upward trend for the month of May 2003. I do agree that they will have similar trends. However, this comparison between the charts shows quite a daily difference. The two charts really do not look very similar at all, especially once you look at the 25-day Moving Average (the red line). Using the FNMA chart does provide a definite advantage in giving your customer the correct information. My contention is you need every edge you can get to provide a pricing advantage for your business and your clients. By using the FNMA bond to guide in decision making over the use of the 10-year Treasury note, you will have a decided edge over those who only use the 10-year Treasury note as a pricing guide. The net effect will be increased market awareness on your part and the perception of increased market expertise in the eyes of your clients.