Summary
Rapid increases in U.S. Treasury yields have led holders of mortgage-backed securities to reduce interest-rate risk by selling Treasuries, a reaction that likely intensified a broad bond selloff this week and contributed to the largest rate spike seen in about a year. Rising yields, triggered by stronger-than-expected inflation data for April and expectations that the Federal Reserve will raise rates this year rather than cut them, have heightened convexity-related hedging among mortgage investors.
Market moves and metrics
U.S. yields have advanced sharply in recent weeks. The benchmark 10-year Treasury yield was last reported at 4.62%. On Tuesday it climbed to 4.69%, the highest reading since January 2025, while the five-year yield reached 4.35%, marking a 15-month peak for that maturity. Overall, the 10-year yield has risen about 23 basis points over the past week and is more than 60 basis points higher since the onset of the U.S.-Israeli war on Iran.
These moves have increased the urgency for investors holding mortgage-backed securities to address the changing risk profile of those assets. Because cash flows from MBS depend on homeowners' refinancing behavior, a sustained rise in interest rates reduces the pace of prepayments, which in turn extends the duration of these securities and raises their sensitivity to further rate changes.
Why convexity hedging matters
Duration measures how much a bond's price will change in response to interest-rate moves, and convexity describes the curvature of that relationship. Most plain-vanilla bonds have positive convexity: their prices rise faster when yields fall than they fall when yields rise. Mortgage-backed securities are different because they contain an embedded prepayment option. That feature can create negative convexity: when rates rise and refinancing drops off, MBS tend to fall more sharply because the expected stream of principal repayments slows and the effective life of the security lengthens.
To manage that risk, large MBS holders - including insurance companies and real estate investment trusts - typically cut duration by selling Treasury futures. This process, known as convexity hedging, can involve substantial flows into Treasury futures markets and thereby put additional upward pressure on yields.
"The velocity of the move in yields has been concerning and we have seen some forced selling because of convexity hedging," said Vishal Khanduja, head of the broad markets fixed income team at Morgan Stanley Investment Management in Boston.
Evidence of hedging activity
Market data showed heavy turnover in U.S. Treasury futures coinciding with the recent yield spike. There were outsized block trades in five- to 10-year note futures; the largest single reported transaction was a block of 33,000 contracts in five-year note futures, according to CME Group data. Traders noted that typical large transactions in these contracts more commonly range from about 5,000 to 8,000 contracts, underscoring the unusual scale of recent activity.
Fed policy, balance-sheet runoff and market convexity
An additional force amplifying the market's negative-convexity dynamic has been the Federal Reserve's quantitative tightening program. Under current policy, about $35 billion of MBS are allowed to mature and the proceeds are being placed into Treasury bills each month instead of reinvesting in new MBS. That approach transfers the negative convexity that the Fed had been sheltering on its balance sheet back to private-market investors.
"This effectively moves the negative convexity of MBS from the Fed's balance sheet back to the market," said Harley Bassman, managing partner at Simplify Asset Management. Analysts note the Fed is in the process of winding down this program; when quantitative tightening ends, those monthly flows will stop amplifying the negative convexity effect in the broader market.
Size and composition of the MBS market
Market participants point to structural features that make today's convexity dynamics more potent than in recent years. The market now includes more than $2 trillion of mortgage-backed securities carrying coupons of 5% or higher, a share that has grown steadily. Higher-coupon MBS are more reactive when interest rates rise, meaning the MBS sector as a whole has become increasingly sensitive to rate moves.
As older, lower-rate loans are retired and replaced by higher-coupon mortgages, the bulk of outstanding MBS behaves more like longer-dated bonds precisely at a time when yields are climbing. That can push the duration of MBS up quickly as rates rise, prompting heavier hedging activity that can feed back into higher Treasury yields.
Amrut Nashikkar, managing director and head of derivatives strategy at Barclays, described this year's convexity hedging as a significant driver of rates and volatility. He said it is "more destabilizing for rates markets" than similar periods in 2023, when Treasury yields were at comparable levels.
Historical context within the market
Convexity flows in recent years have not approached the scale seen prior to the 2008 global financial crisis, when government-sponsored enterprises were substantial active hedgers. Fannie Mae and Freddie Mac managed large duration gaps between assets and liabilities before scaling down their mortgage portfolios after the crisis. At the peak of the Fed's prior quantitative easing program, the central bank held roughly a quarter of the total MBS market, without hedging the convexity risk itself.
Conclusion
The rapid rise in U.S. Treasury yields following stronger inflation data has prompted sizable convexity hedging from mortgage investors, who have sold Treasuries to reduce duration risk in their MBS portfolios. That selling pressure has likely amplified the Treasury selloff this week and contributed to heightened volatility in rates. Fed balance-sheet runoff and the growing share of higher-coupon MBS have reinforced the sensitivity of the market to rate moves, a dynamic that market participants say has been a meaningful contributor to recent moves in yields and volatility.