Rate-Hike Expectations Pressure U.S. Mortgage Bonds as Bank Demand May Weaken Further

U.S. mortgage bonds came under renewed pressure as rising Treasury yields, higher oil prices, intensifying inflation concerns and expectations for Federal Reserve rate hikes drove a broad selloff in September.

Investors withdrew money from U.S. mortgage-bond funds for three consecutive weeks, with the outflows ranking among the seven most severe periods since early 2021. The U.S. mortgage-backed securities index recorded its second-worst monthly performance on record during September.

Mortgage-backed securities are highly sensitive to sudden swings in bond yields because those yields help determine borrowing costs across the economy. When interest rates rise, homeowners generally refinance less often, leaving investors holding lower-yielding mortgage securities longer than expected.

Tighter Federal Reserve policy and a flatter yield curve may further weaken demand from banks, which are important buyers of mortgage-backed securities.

Mortgage rates have climbed to their highest level since 2023, weighing on refinancing and home-buying demand. That could slow growth in home prices and loan balances and reduce the supply of mortgage-backed securities by the end of the year.