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A strong jobs report on the heels of hawkish warnings from the Federal Reserve sent yields on 10-year Treasury notes soaring to a 15-year high Thursday — a path mortgage rates are likely to follow.

Federal Reserve policymakers refrained from hiking rates Wednesday after wrapping up their latest meeting but signaled that they were likely to raise the short-term federal funds rate at least once more this year, and hold rates higher for longer.

While Federal Reserve Chair Jerome Powell provided his usual assurances that future decisions would be data-dependent, a surprising unemployment claims report convinced bond market investors that the Fed will be forced to take an aggressive approach.

The Department of Labor reported that initial unemployment claims during the week ending Sept. 16 fell to the lowest level since January. At 201,000, claims were down 20,000 from the week before and came in 11 percent lower than the 225,000 claims economists polled by Reuters and Dow Jones had forecast.

10-year Treasury yields surged Thursday

Source: Yahoo Finance.

Knowing Fed policymakers are fixated on the tight U.S. labor market and rising wages as drivers of inflation, bond market investors shunned 10-year Treasury notes Thursday, sending yields climbing by as much as 14 basis points to a high of 4.49 percent — a level not seen since Oct. 2007.

The Mortgage News Daily rate index, which tracks rates offered by wholesale, correspondent, and retail lenders, showed rates on 30-year fixed-rate mortgages also jumped by 14 basis points Thursday, to 7.47 percent.

The drop in jobless claims “is a real surprise,” Pantheon Macroeconomics Chief Economist Ian Shepherdson said in a note to clients.

Ian Shepherdson

“We had thought that the low claims numbers in the past two weeks were due to the impact of Hurricane Idalia, on the grounds that major storms often depress claims at first because people have better things to do in the face of a hurricane … than make a jobless claim,” Shepherdson wrote. “That idea now looks a real stretch, given that the storm moved offshore on August 31, and these claims data are for the week ended September 16.”

Pantheon tracks Worker Adjustment and Retraining Notification (WARN) filings that companies submit to state and local governments when laying off employees, which dropped sharply in August before rebounding in September.

“It’s possible that the August drop is temporarily depressing claims, in which case they will rebound in due course,” Shepherdson said. “For now, though, the numbers are much lower than we expected, and are consistent with our initial forecast of a 200,000 increase in September payrolls.”

Because investors view 10-year Treasury notes as a comparable investment to mortgage-backed securities (MBS), yields on the long-term bonds are a dependable indicator of where mortgage rates are headed next.

Wide ‘spread’ between bond yields and mortgage rates

Source: Federal Reserve and Optimal Blue via St. Louis FRED

But the “spread” between 10-year Treasury yields and rates on 30-year fixed-rate conforming mortgages has widened from about 2 percent before the pandemic to an average of 2.88 percent this year.

That’s in part because investors who fund most mortgage loans fear that loans taken out today are likely to be refinanced at lower rates when interest rates come down.

As prepayment risk diminishes, the spread between Treasury yields and mortgage rates may return closer to historical norms, meaning that if the Federal Reserve eases next year, as expected, mortgage rates could come down faster than Treasury yields.

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Email Matt Carter

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