Continued tariffs against MBS holders, especially China, could keep rates elevated
Mortgage interest rates are staying stubbornly high thanks in part to big spreads between rates in mortgage-backed securities (MBS) and treasury markets – and the prominence of China, which has faced steep tariffs by the Trump administration, in the MBS market is increasing uncertainty and volatility.
For now, the US and China have agreed to a 90-day pause on that tariff war. But either way, there’s still plenty of unease at play, leaving one financial expert concerned about what might happen to mortgage interest rates.
Eric Hagen (pictured top) is the managing director and mortgage and specialty finance analyst at BTIG. Previously, he served as an analyst at the US Department of the Treasury. He said the current rate spreads between MBS and treasuries are unusually large.
“Spreads are historically wide,” Hagen told Mortgage Professional America. “We’re talking about 150 basis points over treasuries. Historically, that’s been closer to 100 or 110 basis points. We’re talking about an $8 trillion market of MBS. The sources of demand, and the investors in the mortgage market directly influence the cost of credit.”
Hagen notes that a significant portion of the demand in the MBS market originates from overseas. With many of these countries on the receiving end of tariffs, analysts are closely monitoring their actions to see what steps they take next.
“Overseas buyers, foreign demand, has been an important source of demand for mortgage backed securities,” he said. “That’s obviously being called into question because of the tariffs and because of the support for treasuries and the dollar in general.”
The MBS market is a significant factor influencing mortgage rates, with the wide spread between MBS and treasuries one of the reasons some thought the Federal Reserve would cut rates last week. Instead, the Fed decided to pass on a rate reduction, a move that some experts criticized.
China, Japan, and Canada could hold the cards
Two of the largest investors in the mortgage-backed securities market are China and Japan.
“China and Japan own around a quarter of a trillion dollars of mortgage-backed securities each,” Hagen said. “So we’re talking about half a trillion dollars for basically two investors, which is huge. Canada also has a decent-sized position.”
Hagen notes there isn’t definitive evidence that these countries have sold these securities, but the prevailing wisdom is that they likely have offloaded at least some of their holdings.
“Flight from the dollar is putting upward pressure on spreads,” he said. “While mortgage interest rate volatility is relatively high, that’s usually the reason why spreads in the MBS market stay relatively high. And the consensus among a lot of investors is that spreads will stay wide because of the lack of demand from foreign buyers.”
If negotiations fall through and high tariffs remain, Hagen believes it could lead to higher interest rates over the next three to six months.
Texas-based mortgage broker Hunter Bolling advises that mortgage rates are influenced by more than just the Federal Reserve. https://t.co/wgdGw45chf
— Mortgage Professional America Magazine (@MPAMagazineUS) May 9, 2025
“I think mortgage rates stay high even if we get a rally in the treasury market, and treasury rates come down,” Hagen said. “The expectation is that mortgage rates might lag a little bit, because there is less support, or spottier support in the secondary market.”
Hagen also believes the Fed may continue to allow mortgages to be dropped off its balance sheet if these conditions persist. There is also a question about how long the Fed will go before opting to cut rates again, after deciding to leave rates alone last week.
“Another outcome is that the Fed is less likely to do anything to its retained portfolio,” he said. “They’re currently letting around $20 billion of mortgages run off their portfolio each month. The expectation in the market is that they kind of end quantitative tightening (QT) sooner, and if there’s less demand from the foreign buyers, they could end QT sooner.”
‘Abnormal’ conditions in the market
The combination of high spreads in the MBS market, along with a slight decrease in rate volatility, is not a typical occurrence, according to Hagen.
“It is abnormal to see spreads stay this wide, with interest rate volatility coming down or moderating a bit,” he said. “A lot of that we can attribute to foreign demand. It’s not just an MBS thing, it’s treasuries too. The foreign support for treasuries is the bedrock of that whole picture. The tariffs are having a very meaningful kind of secondary effect on interest rates.”
Even though Hagen believes that rates could go higher, he also notes a lot of the uncertainty makes that hard to predict. He said that under normal circumstances, some of the things happening in the markets would normally drive rates down.
“Thinking constructively, I think there is a real opportunity for mortgage rates to come down, even as we say those rates could stay high,” Hagen said. “There is a lot of magnetic energy for rates to fall because spreads are wide. So, there are catalysts that could support mortgage rates falling.”
He believes that other actions could be taken to provide potential mortgage borrowers with some relief.
“Interest rate volatility does have room to fall,” Hagen said. “Banks could come back into the market in a meaningful way. They’re probably underinvested in the mortgage market right now relative to what they could do. There’s legislation out there around the supplementary leverage ratio, which supports banks taking more leverage on their balance sheets for treasuries and government securities.
“If that goes through, that could be very supportive for mortgage spreads and treasuries.”
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