I’ve received a few questions this week about the recent downgrade of the US. Let’s take a look.

Earlier this week, Moody’s (a credit rating agency in the US) downgraded the United State’s credit rating to Aa1 (one level below the highest available AAA).

Moody’s was the last of the three major credit rating agencies to make this move. Fitch downgraded the US in 2023 and Standard & Poor’s made a similar move in 2011 (both moving the US down one level below the top grade AAA)

Moody’s Downgrade

The Moody’s downgrade announcement focused on the growing deficit and the ongoing dysfunction and gridlock in Washington. Many took this decision to downgrade the US in the present moment as politically motivated given that it directly coincides with negotiations on the latest budget bill. That bill (still being debated in Congress) includes provisions that will further increase the deficit which already stands at over $36 trillion such as making the 2017 Trump tax cuts permanent (they are set to sunset at the end of 2025)

Moody’s described the US financial system as stable and deemed the dollar strong and reliable but did acknowledge ongoing political uncertainty and expressed concern that the US continues to leave major long term financial challenges (like social security and Medicare) unresolved.

Immediate Impacts

Equity markets appeared to take the downgrade in stride earlier in the week, likely in large part due to the fact that they were the last rating agency to make such a move and they only lowered it one notch.

However bond markets reacted a bit differently, especially as the week progressed. Rates across the curve (but especially at the longer end) trended higher throughout the week (which did eventually put downward pressure on equities as well). It’s impossible to know if this rise in rates is due to the downgrade (lower demand for US debt would cause rates to rise) or if there are concerns over the latest proposed tax bill (that will further increase deficits and may drive ongoing inflation) but whatever the reason, the bond market was clearly showing some level of concern

Longer-term Impacts

The rating change itself is unlikely to have a major impact on markets. However, the underlying issue raised by Moody’s – the deficit – does have real implications for the US economy. It remains in the US best interest (and the world’s best interest) to take a closer look at its spending and determine if there are solutions to at the very least slow the growth in the deficit. There also needs to be a continued focus on price levels/inflation as that can also lead to higher expected rates on US debt.

An article I read this week quoted J. Paul Getty and illustrated for the whole world needs to pay attention to this issue – “If you owe the bank $100, that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.” Swap out $100 million for $36 trillion+ and you can see how this is not just a US issue. It truly is in virtually every country’s best interest that the US remain a credit worthy lender and finds a way to keep its balance sheet under control.

Markets were largely unphased at the initial announcement, leading a client to ask me what the potential impact was.