What Do Mortgages Have to Do with Bond Yields?

That’s the question that I’ve heard from a few readers and clients. Fortunately, the Ahead of the Tape column answered that exact question today:

"When Treasury yields rise, yields on bonds backed by mortgages tend to rise more. Higher mortgage rates make it less likely homeowners will either refinance their mortgage or buy a new home. Fewer prepayments mean mortgage investors risk holding more mortgages on their books than they expected. To counter that, they readjust by either selling mortgages or selling Treasurys as a hedge. Both of those things drive Treasury yields and mortgage rates higher — and can push more mortgage investors to sell.

Until yesterday, many mortgage investors appear to have been sitting out the rise in rates. But economic strength and rising interest rates overseas in combination with a Federal Reserve that market participants see as increasingly unlikely to lower rates finally forced their hand.

Mortgage portfolios may be back in balance, which could stem the selling for now. But if rates stay high, many of the debt-financed transactions private-equity firms have been using to acquire companies will be a lot higher. At the same time, the recovery in the housing market that investors keep hoping for could get pushed back."

That’s also an apt example of "reflexivity" — George Soros’ explanation for the impact of a (relatively) small market action could have on the broader market.

Bond analysts have been looking for a rate cut because, as Marketbeat explained, "benchmark Treasurys rarely trade at a level below the federal-funds rate unless more rate cuts look imminent." Hence, that’s the main reason many of the bond gurus were (incorrectly) looking for Fed Rate cuts.

Now that the "No imminent rate cuts" has actually penetrated the brain pans of Bond analysts and traders, we can expect a pretty straight run towards 5.25%.


As an aside, when Jesse Eisinger was writing the Ahead of the Tape column, it was rumored to be one of the most read columns in the Journal (He’s now esconced at Conde Nast’s Portfolio).

When Justin Lahart took over the column, he had some pretty big shoes to fill. He was doing a more-than-adequate job, but as of late, he really seems to be blossoming — breaking out from a big base, even. Many of his recent columns have been so sharp, timely and dead on, that I find myself reading that column first — before I even see what’s one the front page. Today’s column is a perfect example.

Kudos !

UPDATE: June 12, 2007 7:06 am

The full article is now on the public WSJ site: 

Mortgage Jitters May Account For Bond Selloff


Mortgage Jitters May Account For Bond Selloff
Justin Lahart
WSJ, June 8, 2007; Page C1

Bonds Get Bashed
David Gaffen
WSJ Market Beat, June 8, 2007, 8:56 am

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What's been said:

Discussions found on the web:
  1. Fred commented on Jun 8

    How much do you want to bet that Bill Gross is in buying the 10 year into the puke fest he helped snowball. That guy is incredible, and deserves Greenspan. Mr DJIA 5000 was obviously talking his book…and CNBC was happy to give him the “bully” pulpit.

  2. dblwyo commented on Jun 8

    BR – couldn’t agree more with your comments about AofTape – then and now. Presumably Jesse and Justin will see it ;).

  3. S commented on Jun 8

    I actually was wondering how much of Greenspan’s influence impacted Gross’s remarks.

  4. vegaman commented on Jun 8

    I hope u guys realise Bill gross’ comments have been on his website for over a week!!

  5. michael shumacher commented on Jun 8


    Almost two weeks now……..but again it does’nt matter until it does.

    Just like the fall on Feb. 27th was because of the Chinese market. That sound you heard on that day was the collective flushing of the toilet by the institutions as the music stopped. They have since realized the error of there ways and have taken the market up farther to entrap retail. Don’t know if it has worked or not but the bond market sure thinks so.


  6. Dale C. commented on Jun 8


    I see the Plunge Protection Team was at work this morning, judging by the action at 9:45 this morning.

    Dale C.

  7. Fred commented on Jun 8

    If you’re looking for any “invisible hand” in these markets, look no further than Goldman and Blackstone…they have $billions at stake on near term coming deals. I expect a sharp move higher, and have covered my hedges.

  8. michael shumacher commented on Jun 8

    I do not know if that is the work of the PPT however it has happened with that sort of regularity that it is not something that is just happening as some would lead you to believe.

    It IS the work of someone or some entity that does not care if it is seen as it makes no attempt to hide what they are doing.

    Almost like what’s going on in AMZN….someone is propping that up through UBS…..everyday for the last few weeks when that gets to the LOD then a bid just magically appears from UBS and whoosh it takes off. Must be the stock buyback …

    and of course the SEC goes and investigates peopole that made $15-20k on “insider information”. They are missing the bigger picture.

    But enough conspiracy for a friday……



  9. Michael C. commented on Jun 8

    Slightly OT, but wondering if any of the astute readers or those in the industry could help me here:

    I’m at the beginning stages of considering to purchase a new home in a new community. My questions are:

    What is the reason specifically that homebuilders are MUCH more willing to take offers on already built homes rather than homes that are still in construction? Is it the way the profit & loss is handled in the books? Do they “lose” money at that much of a greater rate once the house is up and empty? What is their thinking down in the accounting office?

  10. vegaman commented on Jun 8

    Every bear has been stretchered out so many times we dont need the “PPT” to get this market back up, fact is the bond market collapsed and credit spreads barely budged. Notes are massively oversold, when yields in Tens are at a good premium over Fed funds you might see a sell off that holds.

  11. Fred commented on Jun 8

    I like bonds here, and took down some TLT.

  12. bobthebuilder commented on Jun 8

    Mike C. Builders need to get rid of existing inventory, because a lot of money is tied up in houses that sit on the market. The cost to manufacture the building has been paid out and the company needs to get a ROI. An unfinished build can easily be stalled until the market improves, or cheap materials can be used in the manufacture to reduce cost and price the home lower to attract buyers. Finished homes are done and pricing them lower eats away profits and potentially could put them in losses.

    Taxes play an important role in that a home that is owned by the builder cost the builders in property tax payments. This increases the total cost of manufacture and reduces profits. If money is not coming in from older finished builds where do you get the money to start new ones. You don’t. If the older build is not attracting buyers you need to provide incentive to unload it. Newer builds can have upgrades like tiled bath and kitchen. Hardwood flooring, improved landscaping, because those can be added at anytime in the middle of production. Finished builds are as is. You can’t go back and remove installed products and upgrade it. What to you do with all the old product? What is the cost to gut and reinstall? The only incentives they have are attachments, like free cars, rebates, closing costs.

  13. Greg0658 commented on Jun 8

    That brings up a question. If a new house doesn’t sell and the builder puts it into rental status. When does the county begin to collect taxes and for how much without a selling price?

  14. Eclectic commented on Jun 9

    Vegaman (quoting you)– and MS:

    “I hope u guys realise Bill gross’ comments have been on his website for over a week!!”

    I may be wrong but I think that although his comments have indeed been posted for some time now, they’ve been modified according to Pimco’s recently altered upper level 10-y-T target range for rates at the end of their 3- to 5-year forecast period. I seem to remember that was first published as 5.5% and now it’s 6.5%

    I finally had time to listen to Gross’ CNBC interview yesterday, and it confirms my general understanding of those comments, posted earlier, here (a bit on salt and ice):


    …and the slight modification he made over the last day or so to those comments that were reported in the financial media.

    Of significant note in his interview, he has focused on the theme that I anticipate will be the focus on the Fed itself. That is that any higher mortgage rates right now that result from a higher 10-y-T and mortgage rate creep would actually threaten Bernanke’s own U.S. GDP forecasts, currently standing at 2% generally for 2007. Gross said housing effects by mortgage rates now pushing 7% would severely impact housing (if not already impacted) and drive U.S. GDP back down to near a 1% range.

    No, Bill Gross is no short-term bear on the 10-y-T.

    And, yes, he even admitted to a sort of “front-running” world bond markets against a recognition of higher world-wide GDP growth over their forecast period, that Pimco was now essentially exceeding to… and an even higher recognition by him personally over the last day or two.

    Barringo, Gross may have just put you out of the money for our little “last day 2007” 10-y-T yield tango. Actually, if bond vigilantes, Bernanke, Gross or anybody else is going to ratchet-jaw my sweet Bondie higher, I’d rather they do it now than doing the ratcheting in, say, November or December.

    Well, we’ll see… but I’m sticking to my salt and ice discussion. We may have just seen Bondie’s prom dress for next year, and it should still fit her next year.

    I’ll allow you a moment to enjoy the thrill of the rip to 5.25 (because I think it did touch it for a few microseconds), and you see now why I didn’t play the surge… but you ain’t quite there yet, on the close, as you can see:


    You can bet that Bernanke is already sweating buckshot.

  15. jkw commented on Jun 9

    I’m not sure that Bernanke can do anything to move the long bond. If he cuts rates, it will push inflation up, which should push the long bond up. If he raises rates, it inverts the yield curve which puts some upwards pressure on the long bond.

    Cutting rates would also cause the dollar to fall. If it falls enough, people might start selling US treasuries just to get out of dollars.

    There is no way that cutting the fed funds rate will drop mortgage rates if you assume rational traders control the bond market. Which might be a big assumption.

  16. Eclectic commented on Jun 9

    “I’m not sure that Bernanke can do anything to move the long bond. If he cuts rates, it will push inflation up, which should push the long bond up. If he raises rates, it inverts the yield curve [which puts some upwards pressure on the long bond].* ”

    You are correct, jkw.

    *brackets mine – and that upward pressure will dig into the housing market even deeper than now, but it will really squeeze working capital too, and that would have substantial effects in other industries.

    You are also correct, indirectly, via the mechanisms of failed monetarism which I have written about extensively on this blog.

  17. Bob Brooklyn commented on Jun 9

    Wait until the Chinese start doing derivatives–dynastic mortgages will pop up, floated over eons…

  18. bobthebuilder commented on Jun 12

    Greg0658 – appraised value. The house is taxed on the appraised value to the property when it is completed.

  19. Toe of Patton commented on Jun 12

    I read Soros’ book off BR’s recommended reading list, saw the “low rate” mag cover when it came out, and shorted TLT about a month ago. (I’m still mainly long. But, at least this softens the blow to my other holdings…)

    >> of “reflexivity” — George Soros’

    George Soros, you magnificent bastard! I read your book!

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