2024 could see shrinking of "the spread"

No other metrics are at crisis alert levels. What gives?

2024 could see shrinking of "the spread"

In a year suffused with frustration for those in the mortgage industry, one of the most vexing elements was “the spread.” But it’s increasingly promising the gap between the 30-year mortgage rate and the 10-year treasury yield will shrink this year.

Michael Fratantoni (pictured), chief economist for the Mortgage Bankers Association (MBA), helped demystify the year that was and offered some predictions during a webinar on Tuesday. The event was hosted by digital closing provider Snapdocs.

“This has been such a strange environment through the course of 2023,” Fratantoni said, pointing to a chart showing the 30-year mortgage rate depicted in orange and the 10-year treasury in blue, with a gray area between them representing the spread between the two graphs.

Spread remains wide with no clear explanation

“We’ve seen times in the past when the spread has been really wide, but they tend to be rather fleeting,” the economist said. “You look at September of 2008 and March of 2020, and you have a huge increase in the spread. Well, two things in common there – the world was falling apart whether it was the financial crisis or the pandemic.”

What happens when you flash forward: “You look from the middle of 2022 on, we’re at or above those crisis levels of the spread,” Fratantoni said. “And it’s just persistent. It’s been really frustrating for people. If you talk to an investor, this spread is at the 99 percentile, where other indicators of financial market activity just aren’t – there’s nothing else indicating this level of stress. So, what’s going on?” he asked.

“One is just simple math. Rates have been so volatile because the Fed had to move so quickly to try to snuff out the inflation we’ve been experiencing. That gets directly translated into this MBS [mortgage-backed securities] spread and a wider treasury spread. Second, concerns about what the Fed is going to do with their balance sheet because they’re the largest single holder of MBS in the world right now and they’ve been allowing those to roll off. And then we had bank failures last year which resulted in not quite fire sales, but certainly hurried sales of MBS into the market. It’s been really challenging. This is one reason why mortgage rates have gone up even more than other rates you may be tracking.” 

Historically, the typical 30-year mortgage rate is about two percentage points higher than the 10-year Treasury yield. But in 2023, that so-called spread at times exceeded three percentage points. Before the pandemic, Forbes reported, the spread over all available data was 1.69 percentage points. The magazine cites February 2019 when 10-year treasury bonds paid 2.68% while the average 30-year fixed rate mortgage cost the homeowner 4.37% -- a spread at the long-term average of 1.69%. Most of the time, Forbes continued, the spread ranges between 1.5% and 2.0%

This unusual spread, as Bankrate explains, “… is exacerbating the affordability squeeze that has dramatically slowed home sales.” If spreads were normalized, mortgage rates would be in the mid 5s rather than mid 6s in terms of percentage. Lawrence Yun, chief economist for the National Association of Realtors, has said the housing market would revive under a normal spread.

Signs of shrinkage coming soon

Fratantoni sees a silver lining on the horizon in the form of a shrinking of that troublesome spread as the Fed signals future rates cuts rather than hikes.

“With the December meeting of the Fair Open Market Committee, they didn’t send an all-clear but as close as the Fed’s gonna get,” Fratantoni said. “Even [Federal Reserve] chairman [Jerome] Powell said we’re likely at the peak for the cycle, next move is likely to be a cut. They’re beginning to send out signals too that they’re going to slow the rate at which they’re shrinking their balance sheet. And hopefully we don’t have any more bank failures on the horizon. All that is getting better, and we’ve seen the spread go from 300 basis points to most recently 260. We think it’ll keep narrowing over the course of the year, so definitely good news for the mortgage market.”

Want to make your inbox flourish with mortgage-focused news content? Get exclusive interviews, breaking news, industry events in your inbox, and always be the first to know by subscribing to our FREE daily newsletter.