The Disconnect Between Falling Borrowing Costs and Stagnant Mortgage Rates

The U.S. housing finance system is at a crossroads. Despite a sharp decline in broader borrowing costs, such as the 10-year Treasury yield, mortgage rates have remained stubbornly elevated, creating a widening gap that now exceeds 2.3 percentage points—a level not seen since the 2008 financial crisisThe Spread between 10-Year Treasury Yield & Mortgage Rates Is Historically Wide^[1]. This disconnect, driven by structural inefficiencies in the housing finance system, has profound implications for homeownership affordability, market stability, and investor returns.

The Fed's QT and the MBS Market: A Tectonic Shift

The Federal Reserve's quantitative tightening (QT) program has played a pivotal role in amplifying the divergence between mortgage rates and Treasury yields. By mid-2025, the Fed had reduced its holdings of mortgage-backed securities (MBS) by over $1 trillion, a move that starved the secondary mortgage market of liquidity and allowed mortgage rates to rise more rapidly than Treasury yieldsThe Spread between 10-Year Treasury Yield & Mortgage Rates Is Historically Wide^[1]. While the Fed has slowed QT for Treasuries, it continues to unwind its MBS portfolio, exacerbating the imbalance. This asymmetry reflects the unique role of MBS in the housing finance system: unlike Treasuries, MBS are subject to prepayment risk and market volatility, which investors now demand higher compensation forGSE Reform Resurfaces: Challenges and Implications^[3].

GSEs and the Secondary Market: A Fragile Equilibrium

Government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac have long been the linchpin of the U.S. housing finance system. By purchasing mortgages and guaranteeing MBS, they inject liquidity into the secondary market, enabling lenders to originate new loans and keep rates competitiveThe Secondary Mortgage Market Explained: How It Drives Rates^[4]. However, the current regulatory framework has left the GSEs in a precarious position. Despite holding $154 billion in capital as of 2024The Fed cut its interest rate, but mortgage costs went higher^[2], their implicit government guarantee remains a source of uncertainty, particularly as the Trump administration pushes for privatization. A Congressional Budget Office estimate suggests that privatization could raise mortgage rates by 10–30 basis points, disproportionately affecting first-time homebuyersGSE Reform Resurfaces: Challenges and Implications^[3].

The secondary market itself is another source of inefficiency. Unlike the Treasury market, where demand is driven by global investors, the MBS market relies heavily on GSE activity. When GSEs reduce their MBS purchases—as they have during QT—investor demand wanes, pushing yields (and mortgage rates) higherThe Secondary Mortgage Market Explained: How It Drives Rates^[4]. This dynamic was starkly evident in 2025, when the 30-year fixed mortgage rate hit 6.83% in April, even as the Fed cut ratesThe Fed cut its interest rate, but mortgage costs went higher^[2].

Regulatory Reforms: A Double-Edged Sword

Recent policy shifts under the Trump administration have added another layer of complexity. FHFA Director Bill Pulte has proposed aggressive interventions, including directing GSEs to purchase MBS on the open market to narrow the spread between mortgage rates and Treasury yieldsThe Fed cut its interest rate, but mortgage costs went higher^[2]. While this could lower rates by up to 50 basis pointsThe Secondary Mortgage Market Explained: How It Drives Rates^[4], it risks entrenching the GSEs' role as a market stabilizer, potentially delaying much-needed structural reforms. Conversely, full privatization—advocated by Treasury Secretary Scott Bessent—could introduce volatility by removing the implicit government guarantee, a move that might widen spreads further and destabilize the multifamily housing sector, which relies on GSE financing for 40% of its projectsTrump’s GSE reform plan back on the table^[5].

Implications for Investors

For investors, the disconnect between mortgage rates and broader borrowing costs signals a market in transition. Those with exposure to the housing sector—whether through MBS, real estate, or construction—must contend with elevated financing costs and regulatory uncertainty. Conversely, the Fed's rate cuts, while insufficient to bring mortgage rates in line with Treasuries, could provide a floor for economic growth, benefiting sectors like construction and home improvementThe Fed cut its interest rate, but mortgage costs went higher^[2].

The coming months will be critical. If the FHFA follows through on its MBS purchase plans, spreads could narrow, easing pressure on homebuyers. However, if privatization efforts gain momentum, mortgage rates may rise further, compounding the challenges of a slowing economy.

Conclusion

The U.S. housing finance system is a patchwork of legacy structures and evolving policies, with the GSEs and secondary market at its core. The current disconnect between mortgage rates and Treasury yields is not a temporary anomaly but a symptom of deeper structural inefficiencies. As policymakers grapple with the trade-offs between stability and market discipline, investors must remain vigilant. The path forward—whether through GSE intervention or privatization—will shape not only mortgage rates but the broader trajectory of the U.S. housing market.