Mortgage Rate Spreads and the Yield Curve

Why are short term ARM's and the 30 yr. fixed mortgage rates so close in comparison. When usually the short term ARM's have much better rates?

2 Answers

The yield curve has steepened in recent weeks (current difference in yield between the 2yr treasury and 10yr treasury is 208 bps). Generally, when the curve steepens, the difference in ARM rates and 30yr mortgage rates increases. Therefore, one may assume ARM issuance is likely to increase now that the curve has steepened.

However, due to the lack of liquidity in the market, ARM MBS is trading extremely cheap. In other words, the correlation between a steep yield curve and lower ARM rates has decreased. Because lenders can't sell their current ARM production in the secondary market at respectable levels, they can't lower their offered rates.

When liquidity improves, look for ARM issuance to increase.

I like the first answer but I wanted to clarify that the Yield curve, when inverted, effects the indices of which many ARM products are based, which like the first answer states drives the value down (bringing the rates up.) While the 30 year fixed is based on a long term fixed income backed security (eg. FNMA 30yr 5.5% or FNMA 30 yr 6%) so theoretically they can and do move in opposite directions but can also trend in similar directions.

Make sure your tracking the FNMA MBS for fixed loans (not the Ten yr Treasury) and the various indices (LIBOR 1yr and 6 Month) and other short term variable indices for the ARM loans.

The main reason this is important is that different economic news and events effects these bonds and notes differently, and if you are whatching the 10 yr treasury as an indicator of 30 year fixed rates you will be off the mark either a little or completely.