How Treasury Notes Affect Mortgage Rates

Why Now Is Still the Best Time to Get a Mortgage

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Interest rates are at their lowest levels in years. That's because the 10-year Treasury note yield fell to 1.46% on July 1, 2016. Investors fled from European investments after Great Britain voted to leave the European Union.

The yield rebounded after Donald Trump won the 2016 presidential election. Investors felt his tax cuts would create jobs and boost the economy. So they switched to stocks and real estate investments. By December 16, 2016, the rate climbed to 2.60%. That's higher than its 2.24% rate at the beginning of 2016. 

Rates also rose because the Federal Reserve raised the fed funds rate on December 14, 2016. The Fed expected to raise fed funds rate several times in 2017. Expect interest rates to go up when the fed funds rate does.

The following chart visualizes the relationship between treasury yields and fixed mortgage rates, illustrating that they have a symbiotic relationship. The chart compares the rates of a 30-year fixed-rate mortgage to that of a 10-year treasury yield, and features statistics ranging from the year 2000 to 2019.

U.S. Treasury bills, bonds, and notes directly affect the interest rates on fixed-rate mortgages. How? When Treasury yields rise, so do interest rates. That's because investors who want a steady and safe return compare interest rates of all fixed-income products. They compared yields on short-term Treasurys to certificates of deposit and money market funds. They compare yields on long-term Treasurys to home loans and corporate bonds. All bond yields are affected by Treasury yields since they compete for the same type of investor.

Treasury notes are safer than any other bond because the U.S. government guarantees them. CDs and money market funds are slightly riskier since they aren't guaranteed. To compensate for the higher risk, they offer a higher interest rate. But they are safer than any non-government bond because they are short-term. Businesses store their cash in money market funds overnight. It gives them a safe place to park their excess funds for a little bit of a return. That's why the precursor to the 2008 financial crisis was September 15, 2008. That was the day a money market fund almost went broke.

Mortgages offer a higher return for more risk. Investors purchase securities backed by the value of the home loans. These are called mortgage-backed securities. When Treasury yields rise, banks charge higher interest rates for mortgages. Investors in mortgage-backed securities then demand higher rates. They want compensation for the greater risk. 

Those who want even higher returns purchase corporate bonds. Rating agencies like Standard and Poor's grade companies and their bonds on the level of risk. Bond prices affect mortgage interest rates because bonds and mortgages compete for the same low-risk investors who want a fixed return.

Treasury Yields Only Affect Fixed-Rate Home Loans

Treasury yields only affect fixed-rate mortgages. The 10-year note affects 15-year conventional loans while the 30-year bond affects 30-year loans.

The fed funds rate affects adjustable rate mortgages. The Federal Reserve sets a target for the fed funds rate. It's the rate banks charge each other for overnight loans needed to maintain their reserve requirement. The fed funds rate affects LIBOR. That's the rate banks charge each other for one, three, and six-month loans. It also affects the prime rate. That's the rate banks charge their best customers. For these reasons, the fed funds rate affects adjustable-rate loans. These reset on a regular basis. Historical data on fed funds rate reveal that the highest point peaked in 1980 and reached the lowest in 2008.

How Treasury Notes Work

The U.S. Treasury Department sells bills, notes, and bonds to pay for the U.S. debt. It issues notes in terms of two, three, five, and 10 years. Bonds are issued in terms of 30 years. Bills are issued in terms of one year or less. People also refer to any Treasury security as bonds, Treasury products, or Treasurys. The 10-year note is the most popular product.

The Treasury sells bonds at auction. It sets a fixed face value and interest rate for each bond. If there is a lot of demand for Treasurys, they will go to the highest bidder at a price above the face value. That decreases the yield or the total return on investment. That's because the bidder has to pay more to receive stated interest rate. If there is not a lot of demand, the bidders will pay less than the face value. That increases the yield. The bidder pays less to receive the stated interest rate. That is why yields always move in the opposite direction of Treasury prices. Bond prices and bond yields move in opposite directions because those that continue to be traded in the open market need to keep readjusting their prices and yields to keep up with current interest rates.

Treasury note yields change every day. That's because investors resell them on the secondary market. When there's not much demand, then bond prices drop. Yields increase to compensate. That makes it more expensive to buy a home because mortgage interest rates rise. Buyers have to pay more for their mortgage, so they are forced to buy a less expensive home. That makes builders lower home prices. Since home construction is a component of the gross domestic product, then lower home prices slow economic growth.

Low yields on Treasurys mean lower rates on mortgages. Homebuyers can afford a larger home. The increased demand stimulates the real estate market. That boosts the economy. Lower rates also allow homeowners to afford a second mortgage. They'll use that money for home improvements or for purchasing more consumer products. Both stimulate the economy.

When Rates First Fell to a 200-Year Low

On June 1, 2012, the yield on the 10-year Treasury note dropped briefly during intraday trading to 1.442%, the lowest in 200 years. By the end of the day, the rate closed just a bit higher at 1.47%. 

Why was the yield so low? Investors panicked when the jobs report come in lower than expected. They also worried about the eurozone debt crisis. They sold stocks, driving the Dow down 275 points. They put their cash into the only safe haven, U.S. Treasury notes. Gold, the safe haven in 2011, was down thanks to lower economic growth in China and the other emerging market countries.

Investors still hadn't recovered their confidence from the stock market crash of 2008. Also, they were uneasy that the federal government would allow the economy to fall off the fiscal cliff. Add in the uncertainty around a presidential election year, and you had a situation that might not occur for another 200 years.

The yield rose more than 75%, to 2.98% between May and September 2013. The yield started rising after the Fed announced it would taper its purchases of Treasurys and other securities. The Fed had been buying $85 billion a month since September 2011. This was part of its quantitative easing program.