Moody’s downgrades US government issuer rating

On Friday, Moody’s downgraded the US government’s long-term credit rating from Aaa to Aa1, marking the first time since 1917 that the United States has not held the top rating at any of the three major agencies. This action aligns Moody’s view with previous downgrades by S&P (2011) and Fitch (2023), completing a trilogy of reassessments in response to persistent fiscal concerns. Moody’s cited three key structural issues driving the decision:

• Rising national debt: US debt has reached $36 trillion and is projected to rise to 134% of GDP by 2035 if left unaddressed.
• Persistent fiscal deficits: Chronic deficits have been exacerbated by rising interest payments and entitlement outlays, with little offset from tax receipts.
• Lack of structural reform: Policymakers have yet to present a credible plan to stabilize long-term debt dynamics, eroding confidence in the sustainability of US fiscal policy.

Importantly, this downgrade does not change the fundamental picture and was something we wrote about last year. The issues Moody’s raises should be a surprise to no one. In general, rating agency changes are usually a lagging indicator. In our view, the most important near-term catalyst is the current version of the tax bill making its way through Congress.

Market reaction

The market’s initial response has been orderly and relatively muted. This reflects the fact that this downgrade was broadly expected and largely priced in. The contrast between prior downgrade episodes is instructive. In 2011, Treasury yields fell, and the curve flattened as risk aversion and Fed accommodation drove demand for duration. In 2023, yields rose modestly, and the curve steepened, driven by strong economic data and the Treasury’s open-ended increase in issuance. For the current episode, we expect limited directional impact on yields. Investor positioning is more balanced than in April, and the downgrade lacks any shock value.

A key consideration going forward will be shifts in demand composition—particularly as foreign official institutions step back, and more price-sensitive investors become the marginal buyers of higher yields.

What this means for investors

With two prior agency downgrades and years of public debate around unsustainable deficits, the Moody’s action is a formal acknowledgment of well-understood risks—not a sudden catalyst for market disruption. The probability of a US default is no higher today than it was prior to the downgrade.

Despite the downgrade, US Treasuries remain the world’s most liquid and creditworthy instruments, continuing to serve as a cornerstone in asset allocation and risk management. With steeper curves and a wider range of outcomes, active managers are well positioned to capture relative value, manage curve risk, and dynamically shift between sectors. With supply increasing and demand more reactive, expect larger swings in yields around auctions, fiscal headlines, and Fed communications.

We will continue to monitor these developments and provide guidance as conditions evolve. Right now, we are mostly focused on the current budget bill as a near-term catalyst for Treasury moves and impact to term premiums.

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