Why are mortgage rates high when treasury yields are falling?

If you follow financial news closely, you've likely encountered this rule of thumb: mortgage rates usually track closely with the 10-year Treasury yield. When yields on these government bonds drop, mortgage rates typically follow suit, making homes more affordable and refinancing attractive.

Yet, in early 2025, we're observing a puzzling divergence—Treasury yields have fallen, but mortgage rates remain stubbornly high. What's driving this unusual scenario? To understand why your potential mortgage payment isn't getting cheaper despite seemingly positive signs, we need to delve into the mechanics of the mortgage industry and the specific factors currently causing turbulence.

Understanding the 10-year treasury's typical link to mortgage rates

The relationship between the 10-year Treasury yield and mortgage interest rates is usually straightforward. Lenders often use the 10-year Treasury yield as a benchmark when setting rates for loans like 30-year fixed mortgages, partly because the average mortgage is held for roughly 10-12 years before being refinanced or the home being sold. Treasuries are considered very safe investments, so their yields reflect a baseline borrowing cost. When these yields drop, it typically signals lower borrowing costs across the financial system, allowing lenders to offer cheaper mortgages. But lately, this expected connection has frayed.

The tariff effect: How trade uncertainty creates lender caution

A significant factor injecting volatility into financial markets in early 2025 is the implementation of new U.S. tariffs. These trade policies have increased economic uncertainty, disrupted global supply chains, and altered investor behavior. Both the Federal Reserve and Fannie Mae have cited these tariffs as reasons for lowering their 2025 economic growth forecasts and raising inflation projections. This heightened uncertainty makes lenders cautious.

When lenders become wary due to unpredictable economic conditions, they often hesitate to lower mortgage rates even if benchmark yields like the 10-year Treasury fall. Instead, they build in wider margins, often called a "spread" or "risk premium," to protect themselves against potential financial shocks or increased inflation. This caution was evident in early April 2025, when mortgage rates surged following new tariff announcements, despite previous downward trends.

Why MBS investor confidence matters for your rate

To fully grasp why mortgage rates aren't mirroring Treasury yields, we need to understand how most mortgages are handled after origination.

• The Securitization Process: Most lenders don't keep the mortgages they issue on their own books indefinitely. They typically package numerous mortgages together into Mortgage-Backed Securities (MBS) and sell these securities to investors (like pension funds, banks, or foreign entities) in the secondary market. This process, called securitization, allows lenders to replenish their capital to make new loans and helps them manage risk. Agency MBS, backed by government-sponsored enterprises like Fannie Mae and Freddie Mac, form the vast majority of this market.
• Investor Appetite and Risk Premiums: The smooth functioning of this system relies heavily on investor confidence and demand for MBS. When economic uncertainty rises – as it has due to factors like tariffs and shifting inflation expectations – investors demand a higher return (yield) to compensate for the perceived increase in risk. This risk includes the possibility of borrowers prepaying their mortgages if rates fall significantly (prepayment risk) or defaulting if the economy weakens.
• The Role of the Federal Reserve: Compounding this, the Federal Reserve has been reducing its own massive holdings of MBS acquired during previous economic support programs (a process called Quantitative Tightening or QT). With the Fed stepping back as a major buyer, private investors must absorb more MBS supply, leading them to demand higher yields.
• Impact on Mortgage Rates: This demand for higher yields from MBS investors translates directly into the rates lenders offer borrowers. Even if the 10-year Treasury yield falls, if the "spread" (the extra yield investors demand for MBS over Treasuries) widens due to uncertainty or Fed actions, mortgage rates can remain elevated or even rise. Recent data shows this spread has been unusually wide, indicating heightened investor caution. While MBS trading volumes have remained substantial, the key issue is the higher price (yield) investors are demanding for taking on mortgage risk in the current climate.

Crypto mortgages & the secondary market

While distinct from the traditional market, the emerging crypto-backed mortgage space offers a conceptual illustration of how market structure impacts rates. Crypto-backed mortgages allow borrowers to use digital assets like Bitcoin as collateral. However, this market is still nascent and faces significant hurdles:

• Volatility: Cryptocurrencies are known for high price volatility.
• Regulatory Uncertainty: Clear regulations governing crypto assets, especially in lending, are still developing, creating ambiguity for lenders and investors.
• Secondary Market Development: Unlike the established, multi-trillion dollar traditional MBS market, a deep and liquid secondary market specifically for crypto-backed mortgages is not yet fully formed. While real estate tokenization aims to improve liquidity by allowing fractional ownership and trading, it's still evolving. General liquidity concerns are a known factor in crypto finance.

Lenders originating assets that cannot be easily sold or securitized must hold them on their balance sheets, tying up capital and concentrating risk. This inherently increases the cost and risk of origination, necessitating higher interest rates for borrowers. While traditional mortgages do have a secondary market, the crypto example highlights the principle: any factor that hinders the smooth sale of loans (like severely weakened investor demand or extreme uncertainty in the traditional MBS market) forces originators to price in more risk, leading to higher rates for borrowers relative to baseline benchmarks like Treasury yields.

Fed policy, inflation, and other forces shaping mortgage rates

Mortgage rates are never determined by a single factor. A complex interplay of forces is always at work:

• Federal Reserve Monetary Policy: Beyond its MBS actions (QT), the Fed's target for the federal funds rate influences short-term borrowing costs, and its overall guidance shapes market expectations. The Fed held rates steady in early 2025, citing economic uncertainty partly linked to tariffs.
• Inflation: Persistent inflation concerns keep pressure on rates. Lenders price in the risk that inflation will erode the value of future mortgage payments. Recent tariff policies have added to inflation worries.
• Economic Growth and Employment: A strong economy and low unemployment can support higher rates, while signs of a slowdown or rising unemployment might lead to expectations of Fed rate cuts and lower mortgage rates.
• Housing Market Dynamics: Supply and demand within the housing market itself, including inventory levels and buyer affordability, also play a role.
• Lender Competition and Capacity: Competition among lenders can influence the rates offered.

Currently, despite lower Treasury yields at times, concerns around tariff impacts, inflation persistence, Fed policy uncertainty, and potential global economic shifts are prompting lenders to maintain higher risk premiums. They are pricing mortgages based not just on today's Treasury yields, but also on the perceived risks of tomorrow.

What does this mean for you?

If you're watching mortgage rates and hoping for a drop simply because 10-year Treasury yields are down, it's crucial to recognize the bigger picture. Rates are shaped by a confluence of factors, including:

• Market Volatility: Driven by events like new tariff policies.
• Investor Demand for MBS: Influenced by perceived risk and Fed actions.
• Lender Risk Management: Lenders adjusting spreads to account for uncertainty.
• Broader Economic Conditions: Inflation, employment, and overall growth outlook.

As markets potentially stabilize or investors regain confidence, we might see mortgage rates begin to track Treasury yields more closely again. Until then, understanding the multiple reasons why lenders might keep rates elevated—even when benchmark yields fall—is key to making informed home financing decisions.

Bottom Line

While mortgage rates and the 10-year Treasury yield often move in tandem, the current market provides a clear example of why this isn't always the case. Tariff-induced uncertainty, dynamics in the MBS market (including wider spreads and Fed policy impacts), lender caution, and broader economic pressures are all contributing to the current divergence. Staying informed about all these interconnected factors, not just the headline treasury yields, is essential for navigating today's complex mortgage landscape.

The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.