US government debt may come under more pressure this week after the credit rating agency Moody’s stripped the US of its top-notch triple-A credit rating.
Moody’s dealt a blow to Washington last Friday, when it downgraded the US and warned about rising levels of government debt and a widening budget deficit. Moody’s cut its credit rating on the US by one notch to Aa1 from Aaa, becoming the last of the big three agencies to downgrade the US.
The move comes as concerns about the US’s fiscal trajectory have risen. The US national debt now stands at $36tn (£27tn), and economists fear that Donald Trump’s “one big, beautiful bill” – which was blocked by rightwing lawmakers last Friday – could push the deficit higher by cutting taxes.
Explaining its decision, Moody’s warned that it expects the US budget deficit to keep rising, and criticised US politicians for not taking action to improve the country’s fiscal position.
“Successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs. We do not believe that material multiyear reductions in mandatory spending and deficits will result from current fiscal proposals under consideration,” Moody’s said.
“Over the next decade, we expect larger deficits as entitlement spending rises while government revenue remains broadly flat. In turn, persistent, large fiscal deficits will drive the government’s debt and interest burden higher. The US’s fiscal performance is likely to deteriorate relative to its own past and compared with other highly rated sovereigns.”
Investors are hopeful that the move will not have a lasting market impact, although it will focus attention on US debt levels.
Mohamed El-Erian, the chief economic adviser at Allianz, posted on X: “While this is historic and will attract media attention, its market impact is likely to be contained.”
US government debt has weakened over the last few years; prices have fallen, pushing up the yield, or interest rate, on 10-year Treasury bills to almost 4.5%. Yields rise when prices fall.
There may now be more selling pressures, as “the downgrade may indicate that investors will demand higher yields on treasuries,” Tracy Chen, a portfolio manager at Brandywine Global Investment Management, told Bloomberg.
However, Toby Nangle – the former head of asset allocation at Columbia Threadneedle – said that regulators do not tend to differentiate between Aaa and Aa1 when setting capital risk weights. That means banks’ risk-weighted capital asset calculations look unlikely to be affected by the rating change.
“So, does the downgrade matter to financial plumbers this time? From a mechanical perspective, the answer is almost certainly ‘not at all’,” Nangle writes on FT Alphaville.
Stock markets fell heavily in 2011 after S&P became the first major credit agency to strip the US of its credit rating, with the S&P 500 index dropping more than 6% the next trading day.
Markets also fell in 2023 when Fitch lowered its rating on the US by one notch, from AAA to AA+.
This time, the IG market analyst Tony Sycamore reports that there is “only minor risk aversion via IG’s weekend markets, with gold trading 0.27% higher at $3210 and Nasdaq futures down -0.38% after Moody’s announcement.
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Carol Schleif, the chief market strategist at BMO Private Wealth, suggests Moody’s downgrade may make investors more cautious.
“The bond market has been keeping a sharp eye on what transpires in Washington this year in particular,” Schleif said.
The White House communications director, Steven Cheung, criticised Moody’s move, claiming: “Mark Zandi, the economist for Moody’s, is an Obama adviser and Clinton donor who has been a Never Trumper since 2016.”
Zandi, though, is the chief economist of Moody’s Analytics, not of its ratings arm.
Some investors pointed out that the US cannot be forced to default on its debt, as it issues the US dollar.
“Let’s get real. If there’s one asset on this planet with the least chance of default, it’s a US Treasury bond,” said Stephen Innes, the managing partner at SPI Asset Management.
“The US government issues debt in a currency it prints and controls, and it owns the global reserve currency. You don’t default when your central bank can conjure up settlement liquidity with a keystroke. It’s not moral hazard – it’s just an operational fact.”
