Buying the Dip in Fannie Mae/Freddie Mac MBS Amid U.S. Downgrade Volatility

The Moody’s downgrade of U.S. sovereign credit to Aa1 on May 16, 2025, has sent shockwaves through financial markets, with Treasury yields surging and equity markets oscillating between caution and resilience. For yield-seeking investors, however, this turmoil presents a rare opportunity to buy mortgage-backed securities (MBS) issued by Fannie Mae and Freddie Mac at artificially widened spreads—a dislocation fueled by short-term panic rather than fundamental flaws. Here’s why now is the time to overweight Fannie/Freddie MBS.

Why Fannie/Freddie MBS Remain a Contrarian Play

The downgrade has indiscriminately punished all U.S. debt, including MBS, even though Fannie Mae and Freddie Mac—though in federal conservatorship—do not directly carry the federal government’s balance sheet risks. Their obligations are instead tied to the creditworthiness of homeowners and the housing markets they serve. Three factors justify this distinction:

1. Limited Fiscal Exposure to Federal Debt

Fannie and Freddie are not liable for the federal government’s rising deficits or interest costs. Their primary risk lies in housing market performance, which remains underpinned by strong labor markets, low unemployment, and resilient demand. While the Treasury faces unsustainable fiscal trends, the agencies’ conservatorship ensures their capital needs are backed by the U.S. Treasury—albeit indirectly. This structural separation means their MBS are far less exposed to the federal downgrade’s fiscal headwinds.

2. States’ Strong Credit Profiles Shield Housing Markets

The downgrade’s focus on federal fiscal mismanagement sidesteps the robust credit quality of state and local economies. Most mortgages backing Fannie/Freddie MBS are originated in states with strong tax bases, low unemployment, and stable home prices. Even as federal debt climbs, state and municipal debt issuance has remained disciplined, with many states maintaining AAA ratings. This geographic diversification insulates the MBS portfolio from systemic federal risks.

3. Post-Downgrade Volatility Is Historically Contained

History shows that rating agency downgrades of sovereign debt rarely translate into prolonged pain for agency MBS. In 2023, when Fitch downgraded the U.S. to AA+, Fannie/Freddie MBS spreads widened briefly but quickly narrowed as investors recognized the structural separation between federal debt and housing-backed securities. The current dislocation mirrors this pattern, with spreads now offering a premium over Treasuries that exceeds the downgrade’s long-term implications.

The Data Supports a Contrarian Bet

The chart above shows that Fannie Mae MBS spreads have widened to levels not seen since the Fed’s aggressive rate hikes in late 2022. Yet these spreads remain wider than justified by fundamentals. For instance, the 30-year Fannie Mae MBS yield is currently 6.92%, while the 30-year Treasury yield is 5.0%—a spread of 192 basis points. Historically, this spread averages 120 basis points in stable markets. The excess reflects panic, not risk.

Act Now Before the Rally Resumes

Investors who bought Fannie/Freddie MBS during the 2023 Fitch downgrade saw spreads tighten by over 50 basis points within six months. Today’s wider spreads present an even better entry point. As markets digest the downgrade’s limited impact on housing-backed securities, prices will rebound, rewarding contrarian buyers.

Final Call to Action

The Moody’s downgrade has created a once-in-a-decade opportunity to buy Fannie/Freddie MBS at spreads that overcompensate for federal fiscal risks. With states’ strong credit profiles and the agencies’ structural separation from federal debt, the fundamentals remain intact. This is a yield play with asymmetric upside: spreads will narrow, and the Fed’s “higher for longer” stance ensures principal stability. Overweight these bonds now—before the panic fades and the rally begins.