How will Moody’s downgrade of US debt affect mortgage rates?

To add to the list of dramatic events in 2025, Moody’s downgraded U.S. credit by one notch on Friday — from Aaa to Aa1 — raising concerns about mortgage rates. Moody’s pointed to increasing debt and interest payment ratios notably higher than those of comparable sovereign nations.

This downgrade has sparked a range of reactions among market participants, with some suggesting that it may be politically motivated, given the timing and challenges facing the Republican budget and tax cuts. Many argue that the U.S. should not be directly compared to other sovereign nations. Nevertheless, we need to consider the implications of this downgrad on mortgage rates and the housing market.

10-year yield reaction

The downgrade occurred late Friday, leading to minimal market movement, however, bond yields did tick up a few basis points that afternoon. As I write this on Sunday evening, the 10-year yield is trading at 4.48%, with little reaction on Sunday night trading. The debt downgrade itself does not have any legal ramifications, meaning that certain banks or countries are not required to sell their Treasuries, which would typically drive rates higher.

This situation differs from corporate debt, where a downgrade to junk status would compel firms or the company itself to take action. This explains the lack of significant movement following the announcement. 

When S&P downgraded the country’s debt in 2011, the 10-year yield moved lower as QE2 ended and continued to do so after the downgrade on Aug. 5, 2011. We were not facing inflation concerns then and were still experiencing a sluggish recovery from the Great Financial Crisis. So the economic backdrop was much more important back then.

In August 2023, Fitch downgraded U.S. debt just before a key Federal Reserve meeting. At that meeting, the Fed raised interest rates with a hawkish tone, pushing the 10-year yield toward 5%. Shortly after the meeting, the Fed indicated to the market that the rate-hike cycle was over, which led to a massive rally in the bond market, causing the 10-year yield to decrease from 5% to nearly 3.80%.

In my opinion, what has been happening with the economy and the Federal Reserve during the last two downgrades is more critical for the 10-year yield and its immediate reactions than the downgrades themselves. The bond market has been quite volatile this year, and the Fed seems uncertain about its next steps. Additionally, we still don’t have a complete resolution to the trade war.

Any adverse reaction from this event may lead mortgage rates toward 7.25% or higher, which would be the year-to-date high in 2025. What matters for the bond market and mortgage rates is what is happening with the economy and Fed policy, as my examples for the past two downgrades show.

The timing of this downgrade was intentional, as the budget proposed by the Republicans is set to increase the national debt. This is not shocking because all budgets raise the debt; we cannot balance the budget within our demographics and low tax rate base. In 2019, I wrote an article predicting that the debt could reach $71 trillion by 2060, and that estimate was considered conservative at the time.

Conclusion

I am writing on Sunday night and there is currently a mild reaction in the bond market, but I wanted to provide some context regarding what has happened in the past with the two previous downgrades of U.S. debt and how the 10-year yield has responded.

This year has presented us with many challenges that weren’t part of our 2025 game plan.
Despite that, the latest Housing Market Tracker data indicates that existing home sales have shown remarkable resilience, partly because they are rising from historically low levels. Over time, all dramatic events end and this downgrade will be another addition to that list. In the long run, this downgrade may not be as significant an issue as the headlines suggest.