Quick comments on Moody's cut US credit rating

23 May 2025

On May 16, credit rating agency Moody's Ratings downgraded the United States' credit rating from Aaa to Aa1. Alex Grassino, Global Chief Economist, together with the Multi-Asset Solutions Team (MAST), Macroeconomic Strategy Team, share their latest views.

High-level thoughts from Alex Grassino¹:

The US credit rating downgrade happened at a time of significant volatility in global bond markets. Overall, while we do not expect the downgrade to act as a catalyst for a sharp move higher in bond yields, it IS reflective of several underlying factors that could put upward pressure on yields:

• We think the downgrade largely reflects structural concerns about supply/demand imbalances in the US Treasury and global bond markets.
• Moody’s is the laggard in downgrading US government debt. S&P lowered its US credit rating from AAA to AA+ in 2011, with Fitch following suit in 2023.
• The first (and most noteworthy) time this development occurred, in 2011, the structural impact on bond yields ended up being minimal.

In fact, yields at the long end of the curve (10-year and 30-year maturities) continued to decline and were, in effect, LOWER for a couple years after the 2011 downgrade. The underlying dynamics were simple: Given the United States’ position at the center of financial markets and Treasuries being the ‘safe haven’ asset of choice, practical considerations outweighed any ratings actions.

However, we’d highlight three key factors that are different than in 2011, making this latest downgrade more relevant:

1. US public debt has grown meaningfully over the past 15 years.
   US federal debt to GDP is ~120% now, versus ~93% in 2011. Moreover, while the deficit-to-GDP ratio is lower now than in 2011, the structural nature of this metric’s recent increase (as opposed to its cyclical aspect coming out of the 2008 financial crisis) is what makes it worrisome. Finally, interest payments have nearly doubled (from $0.6 trillion in 2019 to $1.1 trillion now) due to a combination of greater debt levels and higher interest rates. This removes flexibility for the government to reduce the deficit simply by trimming discretionary spending.
   
2. Geopolitical dynamics are different now.
   Volatility in US economic policy has led some investors to question the foundation of the US world-reserve status. We think fiscal concerns are amplified in that context.
   
3. Increased debt issuance from other key regions (Europe, most notably) could provide alternative investment sources.
   Legacy global positions such as the Japanese “carry trade” or “basis trade” have come into question and might not generate the same level of demand for Treasuries as they have over the past decade.
   

Latest comments from MAST, Macroeconomic Strategy Team²:

News that the United States has lost its last triple-A credit rating on 16 May (Friday) has put markets on the backfoot: the US dollar weakened, US Treasury yields rose, and US stocks opened lower. Moody’s is the last of the big three credit-rating agencies to downgrade the United States―Standard & Poor’s was the first to do so in August 2011, and Fitch Ratings followed in 2023. In other words, Friday's move wasn’t unexpected, especially since Moody’s had kept its negative outlook on the US credit rating since November 2023 and warned in March 2025 that US fiscal strength has “deteriorated further.”   

In our view, what we’re seeing now is a reflection of a market that continues to be hypnotised by political developments, from tariffs to debates around possible tax cuts. One key question underpinning all this is whether a US recession might be imminent. The two hard data points we focus on most remain on solid footing, for now: US high-yield spreads have tumbled off their recent high of 4.52%, while initial jobless claims remain reasonably low. For now, we expect U.S. growth to slow but not contract.

1 Source: Manulife Investment Management, 23 May 2025 EDT.

2 Source: LinkedIn Social for business (SFB) post “Moody's downgrades U.S. credit rating; markets react” from Emily Roland, MAST Macroeconomic Strategy Team, 19 May 2025 EDT.