Long Term Perspective

The spread relationship between this group of bonds (government agency, mortgage-backed, and asset-backed) and the 10-year Treasury note yield appears a bit odd because one would still expect the U.S. Treasury security to have a lower risk yield than any of these other securities. It is possible that government agency bonds have a lower average yield than the 10-year note because the average maturity of bonds measured in this compilation is not uniform. If government agency bonds have a shorter maturity – such as 5 years rather than 10 years, the government agency issues can have lower yields than the average 10-year Treasury security. However, the normal relationship mostly returned in 2005 and 2006 as these bond rates rose faster than 10-year Treasury rates.  But since the recession and ensuing modest recovery, agency yields slipped relative to mortgage and asset-backed bonds due to flight to quality.

Similarly, asset-backed bonds could have a shorter maturity than the 10-year note, thus creating nominal yields that are lower than the longer-term Treasury security. Mortgage-backed bonds seemed to hold a steady relationship during the 1990s, but the spread differential narrowed from the 1980s to the 90s to the 2000 to 2004 period. This is primarily due to the vast amount of refinancing activity that occurred in those years.  In recent years, the yield on mortgage-backed securities has been brought down by Fed easing and by the Fed’s addition of these securities to its balance sheet expansion.

Short Term Perspective

During latter 2008, rates on mortgage-backed and asset-backed bonds spiked due to recession and credit market concerns.  Government agency yields actually declined during the second of half 2008 due to the recession and because investors saw these bonds as relatively safe with government backing. In 2009, mortgage and asset-backed bond yields declined on an easing in the recession and improved credit markets.  Yields on mortgage and asset-backed securities also eased with help from the Fed adding huge amounts of these to its balance sheet during 2009, 2010, and into 2011.  Rates, however, firmed in in early 2011 as the economy improved and inflation pressures rose from lows seen in late 2010.  At mid-year, rates eased on slowing economic growth.  In latter 2011, there were counter currents on mortgage rates with mildly stronger housing sales and the Fed engaging in Operation Twist, extending the average maturity of its holdings.  And soft economic news and European sovereign risk worries softened rates in 2012.

In October, the government agency spread posted at minus 90 basis points versus minus 91 basis points the month before. The spread on mortgage-backed bonds narrowed to minus 50 basis points from minus 72 basis points in September while the spread on asset-backed bonds rose to minus 68 basis points from minus 74 basis points.

Yields in this segment were up in September with yields for asset-backed bonds up 9 basis points; mortgage-backed bonds up 25 basis points; and government agency bonds up 4 basis points to 1.07 percent, 1.25 percent, and 0.85 percent, respectively.  The yield on the 10-year Treasury note edged up 3 basis points to 1.75 percent.