Chart of the Week: MOVE Volatility Index and Mortgage-Treasury Spread

Source: ICE-Bank of American Merril Lynch, Optimal Blue

Market volatility, both in equity and bond markets, increased sharply this week because of the serial surprises with respect to the direction of U.S. tariff policy. Mortgage markets are impacted in numerous ways by this volatility. The most direct impact observed is from the widening in the spread between mortgage and Treasury rates, a mechanical result of this increase in volatility, as it directly increases prepayment risk, a risk for which investors want to be compensated.

The news surrounding U.S. tariffs and an escalating global trade war continues to upend financial markets. Between the potential impacts of the announced tariffs and the “on again, off again” nature of their implementation, markets continue to react or overreact one way or another each time the news changes.

A week ago, the 10-year Treasury yield decreased to 3.9% but jumped to as high as 4.5% on Wednesday. The increase in the ICE-BAML MOVE (Merrill Lynch Option Volatility Estimate) Index movement over the past week captures these recent swings, as shown by the orange segment in the chart above which represents the daily values for April, in contrast to the prior monthly averages of the MOVE index in blue. Spikes in the index signify increased volatility.

With wider swings in rates, a larger chunk of mortgages moves in and out of the money to refinance each day. When rates hit their low point, refi speeds could jump, and when they swing to the high end of the range, the spigot turns off, and extension risk becomes the concern. Investors in agency MBS are primarily focused on prepayment risk, as these securities have minimal credit risk.  Increases in this risk can widen the spread between mortgage and Treasuries. Based on data from the Optimal Blue Daily Market Briefing, the spread between the 30-year fixed rate mortgage rate and the 10-year blew out to almost 250 basis points this week, as represented by the yellow line segment in the chart. The spread has averaged roughly 230 basis points for the past six months.

The 30-year fixed mortgage rate reached 6.83% this week, a 22-basis point increase over a 7-day period. In addition to the 10-year level, it is also critical to watch this spread. This increase in volatility has not been good news for the mortgage market.