Most of the factors that affect interest rates are obvious, and easy to watch. Once in a while something comes out of left field that has a major impact, however. Today is one of those days.
Background on Data to Watch
The most common index that mortgage-rate watchers follow is the 10-year U.S. Treasury Bond yield. Why is that? Institutional investors—insurance companies, pension funds, etc.—look at several different investment vehicles when investing in debt instruments. Besides U.S. Treasury Bonds of different maturities, they would also consider corporate bonds and mortgage-backed securities (MBSs.)
Treasury bonds and MBSs compete directly, because both are considered very secure. The U.S. Treasury bond is backed by the full faith and credit of the U.S. government, and mortgage-backed securities are secured by mortgages, which are secured by the properties pledged as collateral.
10-year bonds are most closely watched by mortgage-rate watchers because the average mortgage in the U.S. is kept for about ten years, before being refinanced or paid off in some other way. (This could be changing, but it has been true for many years now.)
Naturally, the yield (the interest rate earned by the investor) is lower on the 10-year bond than on MBSs, because they are guaranteed; the investor will get their principal and their return. Historically, the yield on MBSs runs 2% to 2.5% higher on MBSs than on the 10-year T-Bill.
The Disturbance in the Force
Something big happened in the market yesterday, however. Fitch Ratings, one of three major credit-rating agencies in the U.S., downgraded the credit rating of the United States from AAA to AA+. In other words, America’s credit score dropped.
Why The Downgrade?
Primarily, Fitch decided that American politics makes us a less-creditworthy borrower. The use of America’s ability to raise the debt ceiling as a political football made it less certain that we would always pay our debts. Congress has made it clear that they are willing to refuse to raise the debt ceiling without policy concessions, putting into doubt our ability to pay our bills when they come due.
Secondarily, the rapid rise in the national debt due to the deficit spending of every administration since the late 1990s has increased the risk of defaulting on our bills. The rise in interest rates due to inflation has exacerbated that risk.
What Happened to Interest Rates Then?
Today the 10-year Treasury Bond yield jumped from 4.05% at its close yesterday (August 1, 2023) to 4.12% by mid-morning. Not a huge jump, but not an unexpected response to a downgrade in our credit rating.
Fannie Mae’s 60-day yield, which reflects MBS yields, has increased by a similar amount, and we have seen a slight worsening of mortgage pricing this morning.
Where Do We Go from Here?
It’s possible we will see very little change in the short run. While credit ratings are important, investors moving hundreds of billions of dollars a day are very smart and will do their own research and thinking about this. They may move money out of T-Bills, and they may not.
Inflation is coming down, and as I’ve written before, inflation and long-term interest rates are intertwined. While the U.S. economy is stubbornly strong, there are signs it is slowing down, which should cool inflation further and induce the Fed to halt their short-term interest rate increases.
In the meantime, stocks are taking the brunt of the credit rating downgrade this morning, which is likely helping bonds since the same money competes for the same investment dollars.
Looking forward, the downgrade is likely to delay the expected decrease in interest rates that the smarter minds in the room have been projecting for months. The dust will have to settle before we see any significant improvement in mortgage interest rates.
Casey Fleming, Mortgage Advisor and Author of The Loan Guide (2014) and Buying and Financing Your New Home (2023)
About Casey Fleming: Casey Fleming is a veteran mortgage advisor (NMLS 344375) and Author of The Loan Guide and Buying and Financing Your New Home writes extensively about real estate finance, the real estate market, and the relationship between economics and finance. He advises clients throughout California, and is based in the heart of Silicon Valley. He writes articles regularly for several online publications, is a subject-matter expert for two prominent finance-related sites, and is regularly quoted in articles for many other publications.
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