Long Term Perspective

The spread relationship between this group of bonds (government agency, mortgage-backed, and asset-backed) and the 10-year Treasury note yield appears a bit odd because one would still expect the U.S. Treasury security to have a lower risk yield than any of these other securities. It is possible that government agency bonds have a lower average yield than the 10-year note because the average maturity of bonds measured in this compilation is not uniform. If government agency bonds have a shorter maturity – such as 5-years rather than 10 years, the government agency issues will have lower yields than the average 10-year Treasury security. However, the normal relationship mostly returned in 2005 and 2006 as these bond rates rose faster than 10-year Treasury rates.

Similarly, asset-backed bonds could have a shorter maturity than the 10-year note, thus creating nominal yields that are lower than the longer-term Treasury security. Mortgage-backed bonds seemed to hold a steady relationship during the 1990s, but the spread differential narrowed from the 1980s to the 90s to the 2000 to 2004 period. This is primarily due to the vast amount of refinancing activity that has occurred in recent years. Refinancing activity was certainly not the norm in the 1980s, although it was beginning to gain popularity in the second half of the decade.

Short Term Perspective

Government agency bonds were 10 basis points higher than the 10-year Treasury note, on average, in 2006. This compares with a negative spread of 7 basis points in 2005. Mortgage-backed bond yields were 97 basis points higher than the 10-year Treasury, an increase from the 2005 spread of 86 basis points. Asset-backed bond yields were 50 basis points higher than the 10-year Treasury in 2006, compared to being 15 basis points higher than the Treasury security.  The government agency spread dropped to a minus 55 basis points in November. The spread on mortgage-backed bonds rose late in 2006 and, due to subprime problems, rose further to 118 basis points in November 2007. The spread on asset-backed bonds grew to 65 basis points in November 2007.

Yields in this segment were down 28 to 65 basis points in June while the yield on the 10-year Treasury note fell 38 basis points.