Downgrades, Debt Concerns, and the Impact on Mortgage Rates
By, Sara Sutachan, senior research analyst

August 11, 2010

All of the headlines, the problems with U.S. Treasuries, the debt crisis here and abroad are adding another layer of uncertainty to an already uncertain marketplace right now. The main question for housing in particular is where mortgage rates are headed. Standard & Poor’s downgraded the U.S. Treasury and Fannie and Freddie (GSEs) which caused financial market gyrations across the board. However, it is interesting to note that the other two rating agencies, Moody's and Fitch, have not made any changes to their credit rating of the U.S. Treasury or the GSEs.  While some have reported the downgrade is likely to lead to a bump in interest rates, the fact of the matter is the yield on the 10-year Treasury, to which most mortgage rates are tied, has hit recent lows because of what is going on in the global financial marketplace.

Interest rates generally react to future expectations of economic conditions, as well as other risk factors such as repayment risk and default risk. The downgrade was not a completely “unexpected” event, the fact the current market issues including the U.S. debt crisis and deteriorating economic conditions were already built into investor sentiment. Interest rates, including long-term mortgage rates, react to what investors expect to happen in the future. If investors feel uncertain about the stock market or other more risky assets, they would turn to a relatively safer investment. At this point, U.S. Treasuries are a safe haven (regardless of their rating) compared to Europe and elsewhere where debt troubles are more widespread and mounting. Any instrument backed by the full faith credit of the United States government is a relatively safe investment, and markets are proving that to be true as investors flock to that safety. Increased demand for these safe haven instruments has caused yields, thus, mortgage rates to fall.

Because the downgrading of U.S. debt instruments is an unprecedented event, it is still unknown what or how large of an impact this will have on the long-term direction of interest rates. However, moving forward the biggest threat to the housing market is the lack of confidence in the economy in the days, weeks, and months ahead. If we can get over this hump, the markets can recover from the current financial crisis and move back into a recovery mode.

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