Mortgage-related hedging is adding selling pressure to a strained US bond market after long-term Treasury yields rose sharply. Reuters reports the impact is likely smaller than in past selloffs, and one analyst names monetary policy expectations as the main driver.
Benchmark 10-year Treasury yields have surged about 130 basis points since late February, while 30-year yields have climbed 100 basis points. According to Reuters, a war-driven oil-price spike has kindled expectations for multiple Federal Reserve rate hikes over the next 12 months.
The rise has pushed 30-year mortgage rates to a nearly three-year high of 7.4%. As a result, many homeowners stay locked into existing loans rather than refinancing.
How convexity hedging feeds the selloff
When rates rise, the expected life of mortgage-backed securities extends, which can make them more sensitive to further moves in yields. Investors often respond by selling Treasury futures or buying interest rate swaps, a process known as "convexity hedging."
Evidence of that hedging has emerged in recent weeks. By the first week of October, nine megablock trades had been executed in CME-listed Eris SOFR swap futures, according to Mike Riddle, CEO of Eris Innovations.
Meanwhile, open interest in Eris SOFR Swap Futures climbed to a record 866,768 contracts on September 21, more than doubling the previous year's levels.
Mortgage bonds lag Treasuries
Annaly Capital Management's research note said they underperformed comparable-duration Treasuries by 96 basis points, their weakest monthly performance since the banking turmoil of March 2023.
AGNC Investment Corp. said MBS spreads to Treasuries widened by about 13 basis points to 125 basis points in September.
Analysts see a limited effect
Still, how much these flows contribute to the rise in yields remains an open question. Analysts say the effect tends to fade as yields rise, because more mortgages become locked in. Barclays' Amrut Nashikkar said more of the MBS universe is significantly out of the money, which makes further selloffs less destabilizing.
Analysts also said the mortgage market is no longer large enough to exert the same influence on Treasury yields. James Wang, head of macro at US Bank, said "monetary policy expectations are the No. 1 driver of the selloff"
Source: Reuters via Investing.com
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