Surging U.S. Treasury yields hit the mortgage-backed securities market, with U.S. MBS funds suffering historic outflows for three consecutive weeks.

Title context: Surging U.S. Treasury yields hit the mortgage-backed securities market, with U.S. MBS funds suffering historic outflows for three consecutive weeks. Text: As U.S. Treasury yields surge to multi-decade highs, investors are withdrawing en masse from U.S. mortgage-backed securities (MBS) funds. Over the past three weeks, outflows from these funds have ranked among the seven worst since early 2021, reflecting how violent interest rate swings are prompting investors to accelerate their retreat from riskier fixed-income assets. Data show that the Bloomberg U.S. Mortgage-Backed Securities Index recorded its second-worst monthly performance on record in September. This came after large-scale selling of U.S. Treasuries, driven by soaring oil prices, intensifying inflation concerns, and market expectations that the Federal Reserve will raise rates further, pushed yields steadily higher and placed enormous pressure on the mortgage bond market. Mortgage-backed securities are particularly sensitive to sudden changes in bond yields, because U.S. Treasury yields serve as an important pricing benchmark for borrowing costs across the entire economy. When market interest rates rise, homeowners typically reduce mortgage refinancing activity, as the appeal of converting existing low-rate loans into new ones diminishes. This means prepayments on the underlying mortgages slow, forcing MBS investors to hold relatively lower-yielding securities for longer periods and exposing them to greater interest rate risk. Erica Adelberg, a senior MBS strategist at Bloomberg Intelligence, said the Fed's monetary policy tightening and the flattening of the U.S. Treasury yield curve could weaken banks' demand for mortgage-backed securities, even though banks have been important buyers in this market. However, Adelberg noted that there are also some positive factors at play. As mortgage rates rise to their highest level since 2023, demand for mortgage refinancing and home purchases may weaken further, pushing MBS supply down through the end of the year. At the same time, higher mortgage rates could also curb the pace of growth in home prices and loan sizes, further limiting the supply of newly issued mortgage-backed securities. Notably, the September selloff in the U.S. Treasury market has pushed long-term Treasury yields to their highest level in 24 years. Meanwhile, the excess return performance of mortgage-backed securities relative to U.S. Treasuries has remained persistently weak, further dragging down the overall returns of this asset class. Adelberg said that, as a result of these factors combined, the Bloomberg U.S. Mortgage-Backed Securities Index's total return so far this year has fallen to its second-worst level in its 50-year history. Although reduced MBS supply before year-end could provide some support to the market, against the backdrop of further Fed monetary policy tightening and Treasury yields remaining elevated, weak bank demand and interest rate volatility remain the main challenges facing the mortgage bond market.