US yield surge triggers mortgage hedging, adds to bond market pressure
TLT•A roughly 130-basis-point rise in 10-year Treasury yields since late February has prompted mortgage-related hedging that may add selling pressure to bonds, though analysts say the impact is likely smaller than in past selloffs. Thirty-year mortgage rates reached a nearly three-year high of 7.4%, while mortgage-backed securities underperformed comparable Treasuries by 96 basis points in September.
1. Hedging returns
Rising yields have extended the expected life of mortgage-backed securities, making them more sensitive to further rate moves and prompting some investors to sell Treasury futures or buy interest rate swaps to reduce duration. Analysts said evidence of convexity hedging has emerged in recent weeks, including nine large trades in Eris SOFR swap futures by the first week of October, each with at least $200,000 of exposure to a 1-basis-point rate move.
2. Mortgage market data
Daily volume in Eris SOFR swap futures hit consecutive records ahead of the Federal Reserve's September 16 meeting, and open interest reached a record 866,768 contracts on September 21, more than double the prior year's level. Annaly Capital Management said mortgage-backed securities underperformed Treasuries with comparable duration by 96 basis points in September, their weakest monthly performance since March 2023. AGNC Investment said mortgage spreads widened about 13 basis points to 125 basis points.
3. Impact may fade
Analysts said the contribution of hedging to the broader rise in yields remains uncertain and tends to diminish as more mortgages become locked in. Barclays' Amrut Nashikkar said that reduces refinancing incentives and prepayment risk, while Neil Sun of BlueBay Asset Management said the biggest selling pressure may have passed if rates stabilize. US Bank's James Wang said monetary policy expectations remain the main driver of the selloff.
