US bond investors weigh 'convexity' risk in recent Treasury yield decline

Gertrude Chavez-Dreyfuss

Tue, Mar 25, 2025, 3:04 AM 4 min read

By Gertrude Chavez-Dreyfuss

NEW YORK (Reuters) -The caller driblet successful U.S. yields has raised speculation that a question of buying of Treasury securities and derivative products called involvement complaint swaps by owe portfolio managers and security companies was partially liable for their decline.

These purchases are for "convexity" buying that helps offset the effects of owe refinancing to instrumentality vantage of little involvement rates. They could amplify the diminution successful Treasury yields that has taken spot successful caller weeks owed to concerns astir economical growth.

Convexity is simply a word describing however tiny changes successful involvement rates tin person a disproportionate interaction connected an plus manager's portfolio oregon an insurer's equilibrium sheet.

Convexity buying looks to person started aboriginal this month, arsenic yields slid to the lowest since precocious October, from 15-month highs successful February, analysts said.

The benchmark U.S. 10-year yield, which influences the outgo of borrowings connected homes, cars, and businesses, has not moved overmuch since bottoming astir 4.10% connected March 4, aft a 56-basis constituent diminution since February 6. But the output fell 18 bps from March 13 to 4.17% connected March 20.

"There's ever convexity hedging going on," said Gennadiy Goldberg, caput of U.S. rates strategy astatine TD Securities successful New York, citing the magnitude of uncertainty successful markets from mid-January to the extremity of February and aboriginal March.

"It varies successful intensity. But it's a ample capable determination for folks to presumption their portfolios."

When rates fall, owe players including originators, servicers, and investors successful mortgage-backed securities (MBS) - security companies and existent property concern trusts (REITs) -typically displacement hedges connected owe holdings to equilibrium their portfolios.

Mortgages and MBS let borrowers to refinance oregon prepay their loans erstwhile rates fall. These prepayments shorten the mean beingness of the owe bond, reducing its yield, with the terms expanding little than expected erstwhile rates fall. This is called "negative convexity" and leaves investors with little portfolio duration than their benchmark.

While 64% of outstanding mortgages are locked into involvement rates beneath 4%, astir 16% person rates supra 6%, which could beryllium refinanced rapidly erstwhile rates fall, Goldman Sachs, successful a probe note, said.

To support their portfolio duration successful enactment with their benchmarks, MBS investors volition bargain either Treasuries, oregon Treasury futures. They tin besides bargain an involvement complaint swap, wherein they would person a fixed complaint portion paying a floating one, a commercialized that protects against falling rates.