Market Extra: How the mortgage refinancing boom helped drive the 10-year yield to a record low

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A fall in U.S. Treasury yields to record lows is allowing homeowners to refinance their long-term mortgages at lower and more attractive rates.

And investors say the wave of refinancing that comes with every decline in Treasury rates can end up self-reinforcing the bond-market rally, creating a feedback loop of buying (yields fall as debt prices rise). Meanwhile, analysts have puzzled over the 10-year yield’s slide since the beginning of the year, with many pointing to technical factors beyond well-cited reasons like global growth worries.

Refinancing can accelerate the slide in Treasury yields in a roundabout way. When homeowners refinance their loans, they are effectively paying off the principal on their loan early. This shortens the maturity of their fixed payments and the mortgage-backed securities that bundle such loans.

But investors holding mortgage-backed bonds lose out as they are forced to reinvest the prepayments at lower rates. To protect against the risk of dwindling incomes from home loans, these investors will often buy Treasurys with extended maturities, pushing their yields lower.

See: What the Fed’s surprise interest rate cut means for mortgage rates

“The 10-year note is the usual hedging vehicle,” Gregory Faranello, head of U.S. rates at AmeriVet Securities, told MarketWatch.

Other bond fund managers may also need to top up on longer-dated bonds to ensure the average maturity, or the duration, of their portfolio does not veer too far below that of their competing benchmark index.

“When you have a rally of this sort, it creates a significant duration change. A fair amount of buying needs to take place in order to achieve your duration target,” said Michael Lorizio, senior fixed-income trader at Manulife Investment Management, in an interview.

Treasury purchases from real investment trusts, banks and other holders of mortgage-backed securities, reeling from the increased prepayments from homeowners rolling over their loans at lower rates, are some of the players involved in these mortgage related trades.

Indeed, refinancing activity has ramped up. The total applications from homeowners returning to their lenders jumped 15.1% from the previous week, according to the Mortgage Bankers Association. And on a year-over-year basis, refinancing volumes were up more than 200%.

The 10-year Treasury note yield TMUBMUSD10Y, 0.916% fell 7.5 basis points to 0.917% on Thursday, near its record low. This rate is highly watched among economists and investors as it also serves as a benchmark for long-term mortgage rates.

Freddie Mac reported that the 30-year fixed-rate mortgage rate averaged at a record low of 3.29%.

The slump in long-term borrowing costs comes after the Federal Reserve carried out a surprise 50 basis point rate cut on Tuesday in face of heightened worries around how the COVID-19 outbreak could threaten the U.S. economic expansion.

Read: Mortgage rates fall to all-time low amid coronavirus concerns — here’s why you should think twice about waiting to refinance