Interest rates, yields start to recover

U.S. Treasury yields rose sharply this week, sending mortgage rates up with them.

After a huge rally dropped yields, the bottom fell out. Profit-taking and an increase in consumer prices took the air out of the deflation bubble that had been driving Treasury prices up. Traders speculated that the fear of deflation would keep buying in Treasuries steady and the Fed actively making rate cuts to ward off this possibility.

When deflation fears faded, so did interest in Treasuries. The yield on the 10-year Treasury note jumped almost 30 basis points in just a few days. The huge jump in yields influenced lenders to increase rates on most products.

Even though they remain at healthy levels, mortgage applications barely moved last week. Refinancing stayed strong, however, accounting for more than 77 percent of mortgage activity, according to the Mortgage Bankers Association. The 30-year, fixed-rate mortgage (based on zero discount points) is back above 5.125 percent, while the 15-year, fixed-rate mortgage moved to just below 4.625 percent. The introductory rate on the one-year, adjustable-rate mortgage rose to slightly below 3.75 percent.

Economic news has also been encouraging, further pressuring bonds. Housing starts in May rose and building permits were up as well. Industrial production edged into positive territory for the first time in months, and first-time unemployment claims fell to their lowest level in five weeks.

Although economic news has been slanted to the positive side, growing suspicion that the Fed could still cut short-term rates by 50 basis points at the end of the month remains.

The last week of the month will be more important than usual because of the Fed meeting. In addition to a possible big rate cut by the Fed, there will be news on home sales, two consumer surveys and durable goods orders. The big question, however, will be how long Treasuries will be dragged down by the increase in consumer prices.

Bill Steele is financial editor of Interest.com -- a national publisher of mortgage rates and information.

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