How More Bank Buying of Treasuries Lowers Yields
When banks and investors buy more U.S. Treasuries, the price of those bonds goes up. As prices rise, the yield (or return) on the bonds goes down. This is because bond prices and yields move in opposite directions. So, when demand for Treasuries increases, yields fall. Lower yields make it cheaper for the government to borrow money.
How This Affects Mortgage Rates and Homeownership
Mortgage rates, especially for 30-year fixed loans, often follow the 10-year Treasury yield. When that yield drops, mortgage rates usually fall too. Lenders use the 10-year note to help decide what mortgage rates to offer. Lower rates make borrowing less expensive for homebuyers. That means more people may be able to afford a home, which could lead to higher homeownership.
What Has Happened in the Past
In the past, when demand for Treasuries went up, yields dropped and mortgage rates went down. For example, in December 2020, the 10-year Treasury yield hit a record low. At the same time, mortgage rates also reached all-time lows. This made homes more affordable and led to a rise in home sales.
Another example is when the Federal Reserve bought mortgage-backed securities (MBS) during the financial crisis. This program was meant to lower borrowing costs and help the housing market. While experts debated how much the program helped, the goal was clear: boost demand for bonds to reduce interest rates.
New Policy Proposal: Changing the SLR Rule
A new rule being discussed would change how banks are measured under the Supplemental Leverage Ratio (SLR). If approved, banks could hold more Treasuries without needing extra capital to back them. That would give banks a reason to buy more Treasuries. As demand goes up, yields would likely go down. Analysts say this could lower the 10-year yield by 30 to 70 basis points. That could reduce mortgage rates by 0.25% to 0.75%, which would help more people afford homes.
Different Opinions and Market Risks
Not everyone agrees this plan will work as expected. Some experts say the large amount of new Treasuries being issued because of high government debt could cancel out the extra demand. Also, big buyers like the Federal Reserve and foreign central banks are pulling back. That leaves buyers who care more about price. These buyers might want higher yields to make the deal worth it. That could keep yields from falling.
The Role of Inflation and the Bigger Picture
Inflation is another key issue. If people expect prices to rise, they’ll want higher yields to protect their investment. This could keep mortgage rates high, even if banks are buying more Treasuries. Other factors such as market swings or changes in Fed policy can also affect yields and mortgage rates.
Expert Opinion from Andy Green
I wanted to share the perspective of Martin Feinberg Real Estate’s preferred lender, Andy Green. He’s an expert in Real Estate Finance from Capital Mortgage Services. He had some (moderately) bad news about inflation and good news about deregulation.
The Bad News
This week we get inflation data via CPI (consumer price index) and PPI (producer price index). These reports are 12 month rolling averages, so the numbers from May 2024 will fall off and be replaced by the numbers for May 2025 and then averaged over 12 months. The numbers replaced were very low. Expect to see an increase in inflation this week. Remember the bond market’s arch nemesis is inflation. When you buy a bond, you’re guaranteed a fixed rate of return on your investment. Let’s say 4% as an example. Inflation is the only thing eroding your profitability on that 4%. If everything costs more, your 4% buys less. The investment is less attractive. This was the 1st set of inflation reports where tariff effects could show up.
Bad News Came in Moderation
“The Bad News” turned out NOT as bad as most economists had predicted. We got a tamer than expected inflation report which is good for mortgage rates!
Consumer Price Index
The May Consumer Price Index (CPI) report showed that overall inflation rose 0.1% for the month, which was one tenth lower than the 0.2% expected. Year over year, inflation increased from 2.3% to 2.4%, but the market was expecting a 2.5% print.
Also, it does not appear that tariffs were captured in this report. It’s possible businesses still have inventory at lower costs. Or, they’re reducing margins and not passing along the higher costs. The simplest and most likely explanation is that the tariff impact just is not being captured the way some had feared. This is most evident in new car prices, which decreased by 0.3%.
Shelter was also very well behaved. Overall, shelter was reported at 0.3%, with rent at 0.2% and owners’ equivalent rent at 0.3%. Helping us was lodging away from home, which fell 0.1%. This means that Shelter is up 3.86% year over year. However, it’s still overstating inflation by roughly 1%. Without the lag, Core CPI would most likely be around 1.7%, beneath the Fed’s target. The Fed usually looks at the 3 and 6 month run rates. This takes the last 3 or 6 months and extrapolates the recent trend to a yearly figure to show where inflation is heading.
Headline Inflation
3-month: 1% from 1.5%
6-month: 2.6% from 3.0%
Core Inflation
3-month: 1.7% from 2.1%
6-month: 2.6% from 2.9%
The run rates are very telling. Ahead of the potential tariff impact, inflation was very tame and trending below the Fed’s 2% target. So why is the Fed so fearful of inflation and should they be cutting rates preemptively? It’s true that the tariffs could have an impact and they are just not showing up in the numbers yet. But unlike inflation, it’s not persistent and is a one-time price increase.
Additionally, the labor market has been showing signs of weakness. With inflation looking very tame, particularly on a three-month run rate basis, the Fed should be cutting to avoid a potential recession. This is especially true because they are still more than 1% restrictive on the economy. They have room to cut and still be restrictive.
There are signs the economy is slowing and we just received the new World Bank Forecast for Global Growth. The World Bank cut its global growth forecast from 2.7% to 2.3%. They cut the US growth forecast by a larger 0.9% from 2.3% to 1.4%. The global growth forecast is the slowest since 2008, aside from outright global recessions.
The Good News
Scott Bessent, our current Treasury Secretary, wants to see some banking industry deregulation. Don’t worry! We’re not looking at the wild west of pre-2007 that led to the 2008 financial crisis. Currently banks can only invest up to a certain amount of their deposits. Banks take in money at low rates and invest it to earn higher rates. The idea is to let banks buying treasuries not count against their limit of what they can invest in, as treasuries are a risk-free investment. If this passes, banks would likely buy a lot more treasuries sopping up the excess supply in the markets. This would drive down yields on treasuries which would help mortgage rates improve.
Treasury Secretary Scott Bessent‘s proposed deregulation, particularly regarding the supplemental leverage ratio (SLR), advocates for a change to the SLR to allow banks to hold more Treasuries without it counting against their capital requirements. This could lead to increased Treasury demand and potentially lower yields.
If the demand for Treasuries increases and drives down yields, it could potentially lead to lower mortgage rates. In short, most analysts predict a 30-70 bps drop in the 10-year treasury yield should this happen. That would roughly equate to a reduction in mortgage rates of .25% – .75%.
Closing Summary
High home prices, rising mortgage rates, and inflation have made homeownership harder for many families. Changes in the demand for U.S. Treasuries, especially from banks, can help bring mortgage rates down by lowering bond yields. While new policy proposals could support this shift, other forces like inflation, government debt, and investor behavior could make the impact less certain. Still, understanding the connection between Treasuries and mortgage rates is an important part of seeing how economic policy affects everyday life.
If you’re interested in purchasing a home, you can reach out to Martin and Andy.