Carried Away

Were you surprised by the moves in the market on Monday? If you read my work regularly you might not have been as surprised as those who do not, but the drawdowns were shocking in their intensity. While many were nursing liquidity wounds or panicking as number go down, those in the mortgage industry and financial media were dancing the devil’s dance.

Many, including myself, have argued that we were likely to see our fearful leaders do anything and everything they could to keep the markets at nose-bleed levels to ensure smooth sailing until the election. Indeed, shortly before the rout, Nouriel Roubini and Stephen Miran made waves, accusing Yellen of “activist treasury issuance” to do just that.

The gist of the accusation is that by adjusting the maturity profiles of its debt issuance, the Treasury is effectively lowering 10-year treasury yields, muting the impact of the Fed’s rate policy and performing “stealth” quantitative easing (QE). The writers argue that by issuing more T-bills (treasuries that mature between 4 weeks and a year) instead of longer-dated notes and bonds, Yellen has eased economic conditions and increased risk appetite.

When a financial institution sells $1 of bank reserves (or RRP) to buy $1 of T-bills, its overall financial position and ability to lend into risky activities is little changed from either a profit-maximizing or regulatory perspective. However, when that institution sells $1 of reserves (or RRP) to buy $1 of a 30-year bond, its financial position is much changed, and it will have a significant amount of interest rate risk. That interest rate risk may reduce its ability to tolerate other risky assets (portfolio balance) or it may reduce its ability to lend into the economy, because the duration-bearing Treasury securities cannot be leveraged as easily as bills (via repo) or reserves (via lending) for both market and regulatory reasons

All of this is incredibly complicated and a real head-spinner or nap-inducer, but if you want to understand the direction or path housing may take it is critical to have some idea how these levers work. For a good deep dive into many of these topics, I recommend Eurodollar University - especially the early episodes.

Yellen of course vehemently denies the accusation. Whether intentional or not, I believe these Treasury activities absolutely impact the 10-year treasury rate which is critical to credit creation. More importantly though, what happened Monday is an example of how well-laid plans for the casino can quickly go awry.

When I wrote an article for an industry publication in preparation for the start of 2023, I said the following:

To understand the U.S. bond market, which is often the safe haven for the rest of the world, paying attention to the economic health of other countries is critical. Fears of global recession and policy mistakes could actually drive down the 10-year Treasury yield much lower and faster than currently anticipated, while a recent change in Japan’s yield-curve policy could have the opposite effect.

The above was a very sanitized and edited version of what I initially wrote that included analysis from the Bank for International Settlements on global risk. In all of my time in mortgage, I met very few people that actually even understood how rates work, and if they had any understanding, it stopped at the Fed’s door. So, unlike many of my housing analyst peers, I have had my eyes on Japan for some time, sparking me to cover the carry trade over the last several weeks on DNN. In macro land of course, many people cover Japan much more thoroughly than I do, so I encourage you to check them out. Here are 3 folks I believe who have done a good job over the last year or so.

Dario Cox

Weston Nakamura

Michael Gayed

For those who are looking at “turnaround Tuesday” and breathing a sigh of relief, I would caution that not only has the carry trade not completely unwound, but there is still trouble lurking in the markets:

When liquidity conditions are favorable, the average yield is small. Under stressed liquidity conditions, dislocations from fair value result in an increased average yield error

Don’t understand any of that? Higher is not good. Although the Bank of Japan signaled dovishness when one of its deputies, Shinichi Uchida, said that the central bank would not hike rates “when markets are unstable,” Japan will have to figure out how to stabilize its currency as following the announcement, the yen slumped.

Phew, you might say, but not so fast. Are we out of the woods? Is the mortgage industry right to dance? Is the next refinance boom just around the corner to save all those equity-rich homeowners? When I started this post, the 30-year mortgage rate was at 6.52%. After an abysmal 10-year treasury auction it is now at 6.58%. Did you know though that in July, we already had lower rates year-over-year? For the week of July 13th in 2023, the 30-year was 6.96% and 6.89% for that same week in July of 2024. That is not a jaw-dropping decrease of course, but mortgage rates have been coming down steadily since their cycle peak in October of 2023 at 7.79%. Some attribute that drop to fishy issuance at the end of December (see Yellen discussion above). The problem though is that these rate moves have done little to save the housing market thus far:

Since mortgage rates started their way down, the lowest rate reached prior to the events of this week occurred in January of 2024, reaching a low of 6.6%. Because the time between locking your mortgage rate and closing on your home can vary greatly, we should look at sales in February and March to see the impacts. Combined sales (existing and new) in February (non-seasonally adjusted) were 328,000 and slightly better than the 325,000 in February of 2023, but -12.35% below their 25-year average. March sales of 389,000 were actually lower than the 421,000 in 2023 and -19.72% below their 25-year average.

Just how much do rates have to move to impact the housing market materially and turn it around? To understand, we have to look at the historical relationship of mortgage rates to the 10-year treasury as well as the current interest rate makeup of existing mortgage debt. What rate would entice people back into the market in a meaningful way? Additionally, the 10-year Treasury clawed its way back a bit from the roller-coaster plunge on Monday. Has Baby been put back in the corner? And, if so, what does that mean for mortgage rates?

Let’s begin….