This is a reprint from MBS Quoteline:
As the number of reported cases of the coronavirus around the world has increased, the list of school closings, work interruptions, event cancellations, and other consequences has grown. This decline in economic activity has been brutal for stocks but good for bonds, pushing mortgage rates to record low levels.
One commonly heard question is why mortgage rates have not fallen as much as government Treasury yields. There are two main reasons. First, mortgage-backed securities (MBS) have prepayment risk while Treasuries do not. When people refinance, their loans are removed from MBS. This makes MBS less valuable to investors relative to Treasuries during periods of declines and more valuable during periods of increases. In other words, mortgage rates rise and fall more slowly than Treasury yields due to the basic properties of prepayment risk. Second, the large mortgage companies which purchase loans and set mortgage rates have the capacity to process only so much business at one time. Currently, there is more demand for loans and refinancings than these firms can handle, so they have less incentive to pass along the lowest possible rates to customers.
Another question is why Tuesday’s 50 basis point rate cut by the Fed didn’t cause a similar decline in mortgage rates. This answer is much simpler. The Fed sets only short-term rates, and all of those did drop by roughly 50 basis points. However, long-term rates such as mortgage rates are set and influenced by a wide range of factors and are not tied to movements in short-term rates.