How Will the Downgrading of U.S. Debt Rating Affect Mortgage Rates?

Market rates for U.S. Treasuries—particularly the 10-year note—are fundamentally related to the interest rate on new mortgages. As a result, Moody’s downgrading of U.S. Treasury debt on May 16 raised concerns that changes in U.S. government debt risk could affect the outlook for mortgage rates. This downgrading represents the third of the three major credit rating agencies to do so, following Standard & Poor’s (S&P) in 2011 and Fitch Ratings in 2023. With mortgage rates nearing multi-decade highs, could the Moody’s downgrade push rates even higher? 

In 2011, the S&P downgrade prompted both Treasury yields and mortgage rates to fall as investors shifted their portfolios to safer assets. Typically, debt yields would have increased following a credit downgrade as investors would have demanded a higher return for the heightened default risk. However, this downgrade created greater systemic financial market concerns relative to Treasury-specific concerns, triggering the unusual response. 

When Fitch Ratings downgraded U.S. Treasury debt in 2023, neither Treasury yields, nor mortgage rates had any persistent response. The transitory rise in rates following the downgrade likely resulted from debt ceiling disputes, which, in turn, had prompted the credit rating agency to downgrade U.S. debt. By that point in time, Treasuries had already been downgraded by one agency, and they still retained one maximal credit rating. As a result, their split-rated status did not change.  

MORTGAGE RATES, TREASURY YIELDS, AND U.S. DEBT DOWNGRADES 

Source: Board of Governors of the Federal Reserve System and Freddie Mac, accessed via FRED (DGS10 and MORTGAGE30US). 

Moody’s downgrade of U.S. federal debt last month may not have introduced new information to the market, but it did mark the unanimous downgraded status for the three major credit rating agencies. While this downgrade may have had some impact on Treasury yields, the impetus for the downgrade—particularly the outlook for federal debt—likely played a much larger role. 

The recent downgrade comes against the backdrop of ongoing federal budget negotiations that are expected to result in further increases to federal debt. Capital demand growth resulting from increased federal debt is expected to put upward pressure on market interest rates across all asset types, including mortgage rates.  

Although a similar argument could have been made after the passage of the 2017 tax reform, the capital market environment is markedly different. In particular, the Federal Reserve currently maintains a contractionary monetary policy position while tariff-related inflation risk has caused a surge in inflation expectations. These factors have increased expected future interest rates, causing a rise in long-term Treasury yields and mortgage rates. 

The Moody’s downgrade of federal debt brings a greater awareness to the major implications that policy reforms could have on the capital market outlook. If policymakers allow federal debt to continue expanding at an accelerated rate, tighter financial conditions could drive both Treasury rates and mortgage rates persistently higher.  

Because of the influential role of mortgage rates and other interest rates on real estate markets, our experts are continuously monitoring national and international events impacting capital markets.  

Views expressed on The 338 are those of the authors and do not imply endorsement by the Texas Real Estate Research Center, Division of Research, or Texas A&M University.