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Add the prospect of a potential downgrade of the U.S. AAA rating to the list of factors that could continue to push mortgage rates higher next year.
Ratings agency Morningstar DBRS is closely watching whether politicians on Capitol Hill, an increasingly polarized nation, can meet fiscal challenges such as a growing national debt, a looming debt ceiling and inflation.
nicola james
Nicola James, managing director of global sovereign ratings at Morningstar DBRS, said: “We had hoped that there would be checks and balances in place to prevent some of the policies that were seen as creating further fiscal pressures, but now… That’s not the case.” he told Reuters on Thursday.
The Fed lowered short-term interest rates twice this year, on Sept. 18 and Nov. 7, but mortgage interest rates and Treasury yields rose as bond market investors worried that inflation would not ease. I am doing it.
Bond vigilantes and many economists believe that President-elect Donald Trump’s proposed tariffs, tax cuts, and deportations will accelerate inflation and increase the U.S. debt.
Downgrades to the U.S. credit rating by rating agencies DBRS, Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s have exacerbated these concerns, prompting investors to seek higher yields on government bonds and mortgage-backed securities. There is a possibility that you will start asking for it.
DBRS affirmed the AAA US debt rating as “stable” last summer. But the ratings agency said it was monitoring “how political polarization could negatively impact U.S. credit fundamentals over the long term.”
Last November, Moody’s changed its outlook on the U.S. Treasury rating of Aaa, the highest rating assigned to assets with “minimal credit risk,” from “stable” to negative, citing concerns about U.S. bonds and rising interest rates. did.
“With rising interest rates and without effective fiscal policy measures to reduce government spending and increase revenue, the U.S. budget deficit will remain very high and debt affordability will decline,” Moody’s analysts wrote. “We expect it to drop significantly.” “Continuation of political polarization in the country [the] Congress is raising the risk that successive governments will not be able to agree on a fiscal plan to slow the decline in debt affordability. ”
Analysts at S&P Global Ratings on March 27 affirmed the U.S.’s long-term sovereign ratings of “AA+” and short-term “A-1+” as “stable,” but said they would closely monitor the election.
Analysts at S&P Global Ratings said: “This year’s national elections include not only the presidential race, but also seats in one-third of the Senate and the entire House of Representatives.” “Regardless of the outcome of the presidential election, the composition of Congress will continue to play an important role in determining policy outcomes, which are the primary driver of credibility.”
Federal debt approaches $35 trillion
The federal debt has increased by 50% since the pandemic began, from $23.2 trillion in the first quarter of 2020 to $34.8 trillion as of June 30, 2024, according to the Treasury Department.
Another way to think about this debt is to compare it to the size of the US economy. In the 1970s and early 1980s, federal debt accounted for less than 40% of the U.S. gross domestic product (GDP).
Government debt exceeded GDP in 2012 and rose to an all-time high of 133% in the second quarter of 2020 as the pandemic slowed economic output and soared government borrowing. Since then, government debt as a percentage of GDP has fallen to 120% as of June 30, but it is still higher than it was in 1946 after World War II.
When investors in the bond market demand higher yields, the cost of servicing that debt increases. Government borrowing increased in the early days of the pandemic, but interest payments have gradually increased as long-term interest rates have fallen to historic lows.
Interest payments on government debt reach $1 trillion
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But now, with both government debt and long-term interest rates rising, annual federal spending to cover interest payments is now $1 trillion per year, up from a seasonally adjusted annual rate of $508 billion in the third quarter of 2020. far exceeds.
While the federal deficit and rising national debt are long-standing and ongoing problems, a crisis could occur if Congress refuses to raise the debt ceiling, causing interest rates to skyrocket.
Fears that the U.S. would default on its debts were twice a factor in pushing up mortgage rates last year, when negotiators took until the last minute to reach an agreement to raise the debt ceiling. there were.
Analysts at Fitch Ratings said, “The brinkmanship around the debt ceiling and the failure of U.S. authorities to meaningfully address medium-term fiscal challenges that lead to higher budget deficits and higher debt burdens have undermined U.S. creditworthiness. “This suggests a downside risk to the company,” and decided on the AAA rating. Default ratings for long-term foreign currency issuers in the US were negative in last May’s Rating Monitor.
Fitch Ratings ultimately downgraded its rating to AA+ and reaffirmed it as “stable” on August 29.
However, the current debt ceiling suspension is set to expire in January, and Fitch analysts say, “As in 2023, the unusual measures and cash balances will continue to rise in the months leading up to the deadline known as the X date.” “I think it will continue,” he said.
Tax cuts signed into law by President Trump in 2017 are set to expire at the end of next year, and “will be a key policy discussion next year,” Fitch analysts said.
Because most mortgages are funded by mortgage-backed securities (MBS), rising government debt, inflation, and a debt ceiling crisis can all affect mortgage rates.
Because the payments to investors who purchase most MBS are backed by mortgage giants Fannie Mae, Freddie Mac, and Ginnie Mae, investors believe that MBS are slightly riskier than 10-year Treasury bonds. Although it is more expensive, it is considered a similar proposal.
Odetakushi
First American Deputy Chief Economist Odeta Cusi said Thursday that “investor expectations that the Fed will make its first rate cut in September have increased as investors were bullish and perhaps prematurely expected lower inflation and further rate cuts. immediately put downward pressure on mortgage rates.”
“Since then, upward revisions in economic data, including strong employment numbers, and the election have lowered the bond market’s expectations for future rate cuts relative to the Fed’s current expectations, pushing the 10-year Treasury yield from its September lows. This rise also caused mortgage rates to rise. ”
The interest rate on a conforming 30-year fixed-rate mortgage backed by Fannie Mae and Freddie Mac is roughly tied to the 10-year Treasury yield, but the “spread” between the two can fluctuate.
Wider 30-10 spread
The 30-to-10 spread (the difference between the 30-year fixed-rate mortgage rate and the 10-year U.S. Treasury yield (green)) has widened in recent years.
Although the Fed does not have direct control over long-term interest rates, it purchased trillions of dollars of government bonds and mortgages to lower borrowing costs during the 2007-2009 Great Recession and the pandemic, and it has regulated the bond and MBS markets. became an important player.
These bond purchases (“quantitative easing”) left the Fed with a balance sheet of $8.5 trillion, which it reduced by removing maturing bonds and MBS from its books (“quantitative tightening”). I’m trying.
Trade groups in the mortgage and real estate industries have complained that the Fed’s participation in the bond and MBS markets has widened the “spread” between 10-year Treasuries and mortgage rates.
Last fall, as mortgage rates neared their post-pandemic peak, Mortgage Bankers Association CEO Bob Brugsmit appeared on CNBC and urged Fed policymakers to I would like them to make it clear that they have no intention of selling off their balance sheets.” ”
bob bruksmit
But in a follow-up message to MBA members, Mr. Burksmit said that Fed policy “is not the only cause of recent interest rate instability,” and that the government shutdown once again forced Congress to “improve budgetary discipline and effective “We need to take steps to restore policymaking,” he said.
The MBA said at the time that Burksmit “continues to urge policymakers to come together to address budget and spending priorities that thwart the threat of a government shutdown and restore fiscal discipline.” .
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