As the yield curve flattens, that is the spread between long term rates and short term rates is negligible, homeowners are considering making the move from ARM’s to Fixed mortgages [Note: Paid Subscription].

As the supply of fixed mortgages increases when people shift from ARMs because of the flat yield curve, it could mean upward pressure on mortgage rates (ie bond prices down, yields up). Why borrow at a rate for 1 or 2 years when you can have the same rate for 30 years? The effect of the shift in the market is greater in moving from ARM to fixed since roughly 70% of fixed rate mortgages are securitized and 25% of ARM’s are.

But wait! There’s more potential confusion.

The demand for mortgage-backed securities from foreigners is still strong since their yields provide a greater return for investors than treasury notes generally do. Higher demand, means higher bond prices, means lower yields, means long term rates could stay at low levels for a while.

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