A refinancing boom caused by rallying Treasuries could in turn spark more buying of interest-rate swaps and Treasuries as investors hedge against prepayment risk in the mortage-backed securities market. If mortgage rates fall to levels seen in the refi boom last March, investors could buy $45-$72 billion in 10-year interest rate swaps or Treasuries, estimated Adama Kah, mortgage strategist at Credit Suisse First Boston.
Mortgages rates are already nearing 5.55%, a 12-month low, which could jumpstart some of the buying. But if 10-year rates fall another 25 basis points (they were at 3.9% on June 1) and mortgage rates fall to last March's low of 5.38%, the MBS market could be hit with a redux of that refi boom, Kah said. Mortgage rates, which are priced at a spread to 10-year Treasuries, fell to 5.58% on June 1. To be sure, Kah cautioned against predicting another 25bp fall in Treasury yields as rates have just broken the 4% barrier.
As mortgages are called away and their portfolio duration shortens, portfolio managers may buy 10-year Treasuries or interest-rate swaps to lengthen duration. Interest-rate swaps have been the extension vehicle of choice in the mortgage market for the past few years, Kah said.