The 10 Year Bond and You: Why You Care

I've been preparing a post here for a while now about the 10 Year Treasury Bond, and why you need to care about it.

It's a big subject, and it has many facets, which means it's likely good for a several-part posting here. So this post is an introduction to the bond market, and some clues as to why one would post this sort of information on a real estate financing blog.

When you buy a home, or refinance a home, or open a new mortgage of any type, be it a home equity loan or whatever, that mortgage is a bond. The loose definition of a bond in this context, is an instrument created between a lender and a borrower, secured by real property. There is a rate of interest attached to it, delineating what the lender will see if/when the loan performs as it should. Boiled down, it is money lent, with the expectation of performance at a certain gain for the lender.

If you borrow money from an institutional lender, your closed mortgage goes into a large pile with other closed loans that month, or that quarter, whatever. The lender expects that (because they have made you qualify for the loan under certain terms) the loan will perform into the future, at a certain rate of return for its eventual owner.

These piles of loans (called POOLS) are then packaged up and sold to larger investors who have all the pieces in place to deal with your loan - ie: servicing - the methods used to collect your payments, make payments to your hazard insurance, tax payments, issue statements to you every month, foreclosure action, should it become necessary, etc.

The pool is purchased from the original lender, based on a likelihood of performance. The buyer of the pool will pay the originating company a percentage of the capital amount, mostly between 105% - 107%, to get the pool. Large lenders compete for these pools, and the amount they pay for them makes up a pretty hefty chunk of the bond market. The factors that determine what a company like Bear-Stearns will pay for a pool are many: past performance of pools from the selling lender, economic factors - like inflation, other economic indicators, prevailing interest rates, national bond (mortgage) performance rates, etc.

The trading of these pools makes up a HUGE portion of the bond market. The relative success of buyers and sellers of these pools to agree on an equitable price for the pool has a direct impact on prevailing interest rates.

Many years ago, national interest rates were set using the US Treasury's 30 Year Bond pricing. Then a few years ago, the government stopped using the 30 year bond, and went to the 10 year bond to help determine interest rates. They felt the 10 year bond was a better indicator of economic factors in the national mind, and reflected a more realistic method for determining the FED's interest-rate policies.

So the 10 Year Bond has been the leading measure of what interest rates do for several years now. Recently the Government has begun re-issuing the 30 year bond, but interest rates are still based in the 10 Year Bond.

There are 2 parts to the bond market: Price and yield. When the Price to buy a share of a bond goes UP, it's yield goes DOWN. (When it's more expensive to buy a share of a bond on the market, sales slow, and the yield goes DOWN.) When the price goes low, yield goes up.

There are competitors to the bond market as well. These are mutual funds, other stock funds, REITS, etc. When these competitors' rates (purchase prices) go up, their volume goes down. People who would otherwise be buying these are moving to the Treasury market, looking to gain stability in their portfolios. Therefore, ALMOST all the time, when the stock market is healthy, mutual funds returning well, etc, bond PRICES are down, yields UP, because there is less demand for bonds when the open market offers better returns. When the open stock market goes down, and there is more supply than demand, the money goes to the paces where there is the most opportunity for stable return, which is the bond market. This drives pricing UP, yields down. This is not the only factor in the up/down pendulum that is stock markets/interest rates, but it's a major factor.

Here's another factor:

Over the last 36 months, the FED has raised the base-rate by .25 at every opportunity. Something like 26 straight times. That is, up until the last couple of times. It now stands at 5.25.
This is the rate that national banks use when lending money to each other overnight.

When that rate is raised, its impact on the bond market is one of giving less confidence to the bond market as it is, that we somehow need to FIX this imbalance. (lowering the PRICE, raising the yield.)

Since the fed has taken the last two opportunities to NOT raise that base rate, new breath has come into the bond market, raising prices, lowering yields. Pool buyers are now more confident in mortgages (over the last 6 months) as these bond prices have risen.

When the bond yield goes down, so do interest rates, by a directly proportional amount. Pools (bonds) are easier to sell at a profitable price, easier to make money on, and lenders are happy, they lower their interest rates a bit to attract larger pools, making more money for themselves.

So, the reason you care about the bond market is this: When the bond market prices are up, your interest rates are down. It's as easy as that.

Next post: Specific bond market analysis, showing you the daily motion of the market, with it's factors and indicators.