Update 869 – Treasuries Downgraded:
Causes, Costs of Moody’s Rating Cut
The United States’ debt rating was downgraded from Aaa to Aa1 by Moody’s Ratings on Friday. The move makes Moody’s the final of the three major credit rating agencies to move the nation’s credit rating down from triple A to one notch below perfect. Moody’s cited Congress’s long-standing failure to rein in ballooning federal deficits and debt, and its belief that the ongoing Congressional reconciliation fight will represent another failure in that regard.
So far, the immediate impact of the downgrade has been muted. Moody’s essentially told investors something they have known for years: that America’s fiscal health is declining and does not show signs of improving. That said, Moody’s credit rating downgrade speaks to a larger problem of the government, regardless of the party in power: taking on ever-increasing amounts of debt with little thought to how to pay it back, leaving America with less room for maneuverability in the case of future crises.
Best,
Dana
Moody’s Ratings downgraded the United States’ sovereign credit rating from Aaa to Aa1 on Friday, a move that could push borrowing costs higher for the nation in the coming years. The downgrade, the first U.S. downgrade from Moody’s since it first evaluated America’s sovereign creditworthiness in 1919, comes amidst the ongoing GOP push to pass a massive reconciliation bill. The ratings agency believes current proposals will not lead to material multi-year reductions in mandatory spending and deficits. The U.S. is the only major industrial economy to be downgraded by Moody’s in recent years.
The downgrade now hangs over negotiations as House Republicans seek to pass their reconciliation bill before the Memorial Day recess, when they will return to their districts to face constituents pressing them on their effort to give permanent tax breaks to the ultra-wealthy paid for by cuts to Medicaid, SNAP, and other programs for the most vulnerable, while failing to shift the budget onto a fiscally sustainable path.
Moody’s Downgrades U.S. Credit Rating
Moody’s cited the nation’s rising government public debt, which stood at 98 percent of GDP in 2024, is projected to grow to 134 percent by 2035, at which time interest payments on the federal debt and mandatory spending, now 73 percent of expenditures, are projected to grow to 78 percent. Over the next decade, Moody’s expects government spending to increase while revenue remains broadly flat, leading to larger deficits, government debt and interest burden.
Moody’s was the last of the three major sovereign credit rating agencies to lower its measure of the nation’s creditworthiness. Fitch Ratings similarly downgraded the U.S. credit rating from AAA to AA+ in 2023, and S&P Global Ratings lowered its credit rating from AAA to AA+ in 2011. All three agencies cited the nation’s growing debt burden. They now rate America’s creditworthiness as one notch below pristine. The United States now has a lower sovereign credit rating than many similarly developed nations of the same size, including the European Union.
The Trump Administration’s Impact on the Deficit
Moody’s expects that Republicans’ proposed extension and expansion of the 2017 Tax Cuts and Jobs Act (TCJA) provisions, some of which are scheduled to expire at the end of this year, would add around $4 trillion to the national debt over the next decade. The reconciliation package being considered by the House seeks to legislate these tax cuts – a fourth of which would go to the wealthiest one percent of taxpayers – by cutting government spending on Medicaid and the Supplemental Nutrition Assistance Program (SNAP) by over $1 trillion. These programs overwhelmingly support low-income Americans by providing access to health care and food for the most vulnerable households across the country. Moody’s projects the federal deficit will widen from 6.4 percent of GDP in 2024 to 9 percent in 2035 under this proposal.
Outside of reconciliation, Trump’s big proposal for reducing government spending was to eliminate waste, fraud, and abuse through the Department of Government Efficiency (DOGE). As 20/20 Vision has covered many times before, DOGE is an abject failure in this regard. Earlier this month, the Congressional Budget Office reported the federal deficit has increased by $196 billion so far this fiscal year, as increased revenue was outpaced by a huge $342 billion increase in spending. Trump’s spending increases for defense and immigration control were major contributors, while Social Security and Medicare continue to struggle to cover the benefits of retirees thanks to issues with the programs’ long-term unfunded obligations and solvency.
Rather than reining in fraud and abuse, DOGE exacerbated the government’s fiscal situation: DOGE’s claims of cutting $150 billion in spending do not hold up to scrutiny, with the real number likely adding up to not even half that amount. This does not address all the ways in which DOGE likely increased the deficit by cutting enforcement personnel at the IRS, which will cost the government hundreds of billions of dollars in revenue, to the myriad ways that putting a hacksaw to important agencies made them less efficient and functional. The Hill GOP has expressed concern and would have welcomed a way to pay for their tax cuts and spending priorities that did not involve leaning so heavily on social safety net cuts that they know will go over poorly with voters. Instead, as of this week, DOGE does not even have a rescission package to point to as evidence of its success, and its proposed cuts are so small that they are basically a non-factor in the debate over reconciliation or the greater U.S. fiscal condition.
Signals of Sentiment on U.S. Economy Souring, but Little Immediate Impact
Moody’s credit rating downgrade does not bode well for the future of America’s fiscal health. That said, the immediate market reaction to the downgrade was quite muted on Monday. In the stock market, futures over the weekend took a nosedive, and the S&P 500 dropped by 1.1 percent early in trading. By midday, however, the market was calming down, and by close, the S&P 500 edged up by 0.1 percent. Plenty of retail investors were eager to buy the initial dip, and stocks ended the day fairly mixed, but still generally in positive territory.
As for Treasuries, Moody’s downgrade has much more direct significance. Moody’s is essentially warning investors who are interested in buying American bonds that U.S. Treasuries are a less reliable investment now, and that they should not buy them at a low interest rate. As a result, the 10-year Treasury yield went above 4.5 percent on Monday, topping out at around 4.55 percent. Much like with the stock market, however, markets eventually calmed down and yields dropped to 4.45 percent by the end of the day.
The U.S. dollar also weakened relative to other currencies on Monday. For example, the euro rose 0.6 percent against the dollar to $1.1232. In a similar vein, however, the dollar rebounded considerably by midday. Towards the end of the day, New York Federal Reserve President John Williams stated that there had not been a large-scale move away from U.S. assets, with the dollar ultimately losing little ground.
While it may seem counterintuitive that the market responded so little to America losing its sterling credit rating, there is one big reason the markets moved so little: none of this is new to investors. While the downgrade brings renewed focus to America’s declining fiscal health, investors and economists have known for years that the federal government, regardless of administration or party in power, has not done much to rein in the deficit and the national debt. While the downgrade speaks to increased economic uncertainty at a time when there is plenty of that to go around, investors already knew that Washington has demonstrated a pattern of being fiscally irresponsible and has little stomach to increase taxes and cut revenue to meaningfully reduce the deficit. As a result, the factors cited in Moody’s report had already been priced in, and after the initial shock wore off, markets essentially returned to business as usual.
However, even in the light of the markets’ relative complacency, there is reason to be worried about America’s long-term fiscal and economic health, and this was highlighted by Moody’s downgrade. America’s $36 trillion in existing debt means that the federal government will have less room to maneuver if it needs to borrow again in a future crisis, such as another big recession. If the federal government does, in fact, need to borrow large amounts of money in the short term, the loss of its sterling credit rating means that it will not be able to get away with it without experiencing higher interest rates and inflation. The lower credit rating means that the government will have to pay more to borrow money, and when it does, it will likely lead to higher borrowing costs across the economy. In other words, nobody should expect mortgage rates to return to their record lows seen in the aftermath of the Great Recession anytime soon. The timing of Moody’s downgrade was likely meant as a warning to the U.S. federal government about the long-term ramifications of America’s failure to address its fiscal health at a time when the administration seems eager to renege on its promise to lower the deficit if it means pushing through Trump’s agenda.
Risks of Upending Stable Outlook
Moody’s also changed its outlook of the United States’ credit rating – its expectation of the likely direction of the credit rating over the medium term – from negative to stable, with the expectation that effective monetary policy led by an independent Federal Reserve will continue. The outlook is also underpinned by an expectation that the constitutional separation of powers among the three branches of government will remain strong.
The Trump administration has threatened both the independence of the Fed’s monetary policy decisions and the long-standing system of checks and balances between the three branches of government over the past few months since President Trump took office. The President’s regular assertions of his own monetary policy preferences, paired with threats to Fed Chair Jerome Powell’s position, have been a feature of every recent interest rate decision, and the administration’s demonstrated disregard for judicial rulings, particularly related to its immigration agenda, has led to concerns of a constitutional crisis.
The Trump administration’s potential to undermine the stability provided by the United States’ system of strong, independent institutions is the major immediate threat to the nation’s fiscal condition.