U.S. Treasury Rating Downgrade by Moody’s
Moody’s Ratings has downgraded the U.S. government’s credit rating from Aaa to Aa1, citing rising debt and interest payment ratios that are, “significantly higher than similarly rated sovereigns.” Moody’s noted that, “Successive U.S. administration and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest cost.” The report noted the reduced budget flexibility in federal spending. Rising entitlement cost and reduced revenue, due to tax cuts, are likely to lift the federal debt burden to about 134% of GDP by 2035, compared to 98% in 2024.
Higher borrowing costs since 2021 have contributed to a decline in debt affordability. By 2035 Moody’s estimates that 30% of federal revenues will be used to pay interest, up from 18% in 2024 and 9% in 2021. This compares to 1.6% for other Aaa-rated sovereigns.
Moody’s was the last of the three major U.S. ratings agencies to cut to Aa1 from AAA, S&P was first in 2011 and Fitch in 2023. Moody’s held a perfect credit rating for the U.S. since 1917. The announcement came as no surprise to Treasury investors as the rating agency had previously signaled this action would be triggered if projected fiscal and economic conditions did not improve.
The implication of the rating downgrade may lead to increased volatility in financial markets, with potential impacts including higher Treasury yields, downward pressure on the U.S. dollar, and reduced attractiveness of U.S. equities.
The announcement which came after US. markets closed last Friday, has since had little impact on short-term U.S. Treasury rates, while the 10-year U.S. Treasury rate has risen 10 basis points to 4.59%. While the initial reaction to the downgrade is higher rates, it is unlikely to change the outlook among economists who project slightly lower levels in a range of 4.15% to 4.40% for the 10-year Treasury over the rest of the quarter.
This ratings downgrade is unlikely to change votes in Congress or trigger forced selling of Treasurys. Moody’s conclusion and that the Aa1 and stable rating outlook reflects one of high credit strengths and resilience to economic shocks. In addition, the U.S. dollar’s status as the world’s reserve currency provides significant credit support and extraordinary funding capacity to finance fiscal deficits and growing debt burden. Despite policy being less predictable in recent months, the U.S. has an effective monetary and economic policy that provides financial stability through business cycles.
Sources: BTC Capital Management, FactSet Research Systems Inc., Federal Open Market Committee (Federal Reserve) LSEG I/B/E/S, FTSE Russell (an LSEG Group company), S&P Global, U.S. Bureau of Labor Statistics, U.S. Census Bureau
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