Moody’s Investors Service has downgraded the United States’ long-term issuer and senior unsecured ratings from Aaa to Aa1, marking a significant shift in the country’s financial outlook. This decision comes from growing concerns about the nation’s rising fiscal debt and growing fiscal deficits. The rating agency’s downgrade has already set off dramatic ripples through financial markets, changing the outlook for everything from U.S. government bond yields to the price of gold.
The credit rating agency recently estimated that the federal interest payments will eat up nearly a third of all federal revenue by 2035. This is a huge leap from roughly 18% in 2024 and only 9% in 2021. Moody’s expressed apprehension regarding the sustainability of the US fiscal position, particularly if the 2017 Tax Cuts and Jobs Act is extended. The agency estimates that the federal deficit could expand by around $4 trillion over the next decade under current fiscal policies.
Rising Debt and Fiscal Concerns
Unfortunately, in the last ten years we have watched federal debt from the United States skyrocket. What’s behind this surge? This boom is almost exclusively fueled by persistent fiscal deficits. Moody’s recently stated, “Over more than a decade, US federal debt has increased dramatically as a result of persistent fiscal deficits. At the same time, federal spending has ballooned while tax cuts – both Republican and Democratic – have slashed government revenues. As deficits and debt have ballooned, and interest rates have risen alongside them, the cost of federal government interest payments has skyrocketed.”
This ever-increasing liability cost has triggered concerns over the US federal government’s capacity to honor its liabilities in the future. Analysts warn that long-term economic growth will be unable to match the pace of growing obligations. If that occurs, the dollar value of US bonds is in jeopardy. This is a huge risk, as pointed out by Kyle Rodda in his excellent and detailed explanation of this pernicious provision. This represents a significant new market risk in US debt, he argued—that the very value of US bonds will be at risk if the US economy fails to grow at sufficient rates to pay off government obligations.
Market Reaction to Downgrade
In escalation of Moody’s downgrade, US government bond yields have increased since investors require higher premiums for future risks. On Friday, the yield on the 10-year Treasury note soared by 5 basis points to 4.48%. It further increased in Asia on Monday — reaching 4.51%. Such movements are indicative of investor concerns about the sustainability of US fiscal health.
Gold prices increased as investors flocked toward safe-haven assets in the wake of the downgrade. Gold futures jumped more than 1% at the start but then pulled back to a 0.8% gain, at $2,013 per ounce. That downgrade soured investor appetite for other US assets, like US equities and the dollar. On Monday morning, US equity futures started the day by crashing. As of this writing, Dow Jones Industrial Average futures were down 0.65%, while the S&P (/ES) and Nasdaq Composite (/NQ) were down 0.92% and 1.22%, respectively.
Short-Term Impact Anticipated
While the immediate impact on markets from the downgrade has sent Wall Street into a tailspin, some analysts say its influence will be temporary. As Rodda put it, “I don’t think it will have a lasting impact. But on the flip side, he argued, the downgrade serves to underscore the inappropriate fiscal loosening and the continued structural fiscal crisis of the US. Nonetheless, he thinks that future market corrections may neutralize with a bit of time.
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