Analysts Keep An Eye On Mortgage Rates After Fitch Downgrade

While analysts agree that the Fitch downgrade of U.S. debt will not directly impact mortgage rates, it brought other economic concerns to light. 

The rating agency’s Aug. 1 announcement moving U.S. debt from AAA to AA+ drew mixed reactions across the financial sector. 

“There is no direct effect of Fitch’s downgrade on mortgage rates, but the indirect effect is transmitted through the 10-year Treasury bond that underpins mortgage rates,” said Mark Fleming, chief economist at First American. “The yield on the 10-year Treasury is little changed today, suggesting that the downgrade will have little impact on mortgage rates. Fed policy, inflation and the health of the labor market are much more important.” 

Bill Bodnar, chief revenue officer for mortgage software provider Tabrasa, used a lending analogy to describe what happened. “As a borrower, if you go to take out a mortgage and you are a person that doesn't have a lot of income and has a lot of debt, you get a higher rate because you’re a risk,” he said. “What happened today is the U.S. is a higher risk. They're looking at the fiscal policies and debt we’re taking on and saying this doesn't jive.”

He recalled the last time the country’s debt was downgraded by Fitch in 2011, which was followed by an improvement in mortgage rates. The difference between now and then? Thirty-two trillion dollars in debt versus six trillion. 

“The last time we went through this nightmare, rates actually improved, and it prompted Congress to get their fiscal house in order and control spending,” Bodnar explained.

Some asserted that industry leaders should not have been surprised.

In May, Fitch placed the U.S.' top rating on “rating watch negative,” immediately causing global stock markets to weaken. “That pretty much said the downgrade was imminent,” Bodnar added.

The current Fitch report cited "a steady deterioration in standards of governance over the last 20 years." The agency wrote, "Repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management.”

The decision vexed federal officials, as U.S. Treasury Secretary Janet Yellen “strongly” disagreed with Fitch’s determination. 

The 10-year treasury yield rose to 4.09% on Wednesday, the highest since Nov. 2022, according to Dow Jones Market Data. At the same time, the Dow Jones Industrial Average dropped 188 points or 0.5%. The S&P 500 declined 1%, while the Nasdaq Composite fell 1.7%.

If the treasury yield stays below 4.09%, Bodnar said, “we may very well be hitting the peak” in mortgage rates.

Phil Mancuso, partner at EPM and Appraisal Nation, said that AA+ is “still pretty good.” “It’s very unlikely anyone really believes the U.S. is going to default, so it’s unlikely to have a huge impact,” he pointed out. “That said you can never say never.”

Ultimately, what does all this mean for mortgage-backed securities and mortgage rates? “Well, the S&P dropped about 7% the last time this happened,” Mancuso said. “If we see some flight to quality, which often happens with falling stocks, you’d see lower rates. With many, including myself calling for rate cuts as early as year-end well before this downgrade, one would argue rates are very likely to begin to head lower instead of higher.” 

Fitch went on to downgrade the enterprises Wednesday, issuing Fannie Mae and Freddie Mac Long-Term Issuer Default Ratings (IDR) and senior unsecured debt ratings to 'AA+' from 'AAA'.

The agency said the cut “was not driven by fundamental credit, capital or liquidity deterioration at firms” and instead, a result of the U.S. downgrade.

Bodnar was unsure of the ultimate impact of this on the economy but did emphasize the country’s immense debt burden.

“What is concerning is that debt is not a problem until it’s a problem,” he said. “We’ve been talking about how much debt we have forever. At some point, the market's going to say, ‘you have to pay it back or pay a higher rate.’”