U.S. Treasury Forecast Jumps 0.05% To 0.13% And Tacks On More On

U.S. Treasury Forecast Jumps 0.05% To 0.13% And Tacks On More On Friday

Nov 9 2013, 12:31  

The latest implied forward rate forecast from Kamakura Corporation shows projected 10 year U.S. Treasury yields up 0.05% to 0.13% from last week while fixed rate mortgage yields are 0.04% higher. Mortgage yields, determined by the Monday through Wednesday weekly survey of the Federal Home Loan Mortgage Corporation, lag Treasury movements simply because of the 3-day yield calculation used in the Primary Mortgage Market Survey ®.

1. The 10 year U.S. Treasury yield is projected to rise from 2.63% at Thursday's close (up 0.06% from last week) to 3.074% (down 0.06% from last week) in one year.
2. The 10 year U.S. Treasury yield in ten years is forecast to reach 4.584%, 12 basis points higher than last week.
3. The 15 year fixed rate mortgage rate is forecast to rise from the effective yield of 3.41% on Thursday (unchanged from last week) to 3.855% (up 0.002% from last week) in one year and 5.78% in 10 years, up 0.001% from last week.

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We explain the background for these calculations in the rest of this note, along with some mortgage servicing rights metrics. The forecast allows investors in exchange traded U.S. Treasury funds (TLT) (TBT), total return bond funds (BOND), municipal bonds (NUV) and exchange traded mortgage funds (REM) to assess likely total returns over the next 120 months.

Today's forecast for U.S. Treasury yields is based on the November 7, 2013 constant maturity Treasury yields that were reported by the Department of the Treasury at 5 p.m. Eastern Daylight Time November 7, 2013. The forecast for primary mortgage market yields and the resulting mortgage servicing rights valuations are derived in part from the Federal Home Loan Mortgage Corporation Primary Mortgage Market Survey ® made available on the same day.

The U.S. Treasury "forecast" is the implied future coupon bearing U.S. Treasury yields derived using the maximum smoothness forward rate smoothing approach developed by Adams and van Deventer (Journal of Fixed Income, 1994) and corrected in van Deventer and Imai, Financial Risk Analytics (1996). The primary mortgage yield forecast applies the maximum smoothness approach to primary mortgage market credit spreads, which embed the risk neutral probabilities of mortgage default and prepayment risk. References explaining this approach are given below.

U.S. Treasury Yield Forecast

This week's projections for the 1 month Treasury bill rate (investment basis) show a steeper curve on the long end compared to last week as shown in the graph below. The projected 1 month rate of 4.509% in October 2023 is up 13 basis points from last week. The 10 year U.S. Treasury yield is projected to rise steadily to reach 4.584% on October 31, 2023, 12 basis points higher than projected last week.

(Click to enlarge)

Mortgage Valuation Yield Curve and Mortgage Yield Forecast

The zero coupon yield curve appropriate for valuing mortgages in the primary mortgage market is derived from new issue effective yields reported by the Federal Home Loan Mortgage Corporation in its Primary Mortgage Market Survey ®. The maximum smoothness credit spread is produced so that this spread, in combination with the U.S. Treasury curve derived above, correctly values new 15 year and 30 year fixed rate mortgages at their initial principal value less the value of points. The next graph compares the implied 15 year fixed rate mortgage yield with the implied 15 year U.S. Treasury fixed rate amortizing yield over the next ten years.

(Click to enlarge)

The effective yield on 15 year fixed rate mortgages is projected to rise from 3.411% today to 5.781% in 10 years, unchanged from last week. The 15 year fixed rate mortgage spread over 15 year amortizing Treasury yields is forecasted to widen from its current level of 0.962% to 1.218% in 10 years, down 12 basis points from last week.

Implied Valuation of Mortgage Servicing Rights

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