The bond market is experiencing a significant selloff, driven by a combination of rising mortgage rates and negative convexity in mortgage-backed securities (MBS). As interest rates climb, the duration of MBS extends, prompting investors to engage in convexity hedging by selling Treasury bonds. This phenomenon is exacerbated by a buyers' strike among real-money investors, who are wary of further rate increases and the potential for long-end Treasury rates to reach 5%. The anticipation of inflationary pressures from the incoming Trump administration's policies further fuels the expectation of rising yields.
The option-adjusted duration of the Bloomberg MBS Index has surged, climbing over 6% since December 1 and approximately 13% since mid-September, reaching its highest level since May. This increase in duration risk has led to a wave of convexity hedging, contributing to the upward pressure on 10-year Treasury yields, which have reached approximately 4.79% as of Friday. This marks the highest level since October 2023, with the current yield at 4.75 as of 13:01 on January 10.