On May 18, 2023, Moody's announced a significant downgrade of the U.S. sovereign credit rating, a move that has intensified investor anxieties regarding a potential debt crisis looming on the horizon. This downgrade marks the last of the major ratings agencies to take such action, reducing the nation’s previously pristine credit rating by one notch due to escalating concerns surrounding the country’s staggering $36 trillion debt.
The timing of the downgrade coincides with the ongoing negotiations in Congress, where Republicans are pushing for an extensive legislative package known as the Big Beautiful Bill. This proposed bill includes a mix of tax cuts, increased spending, and reductions in safety-net programs, which could further inflate the national debt by trillions. Investor uncertainty is palpable, as the details of this bill remain unclear, despite a backdrop of optimism regarding trade.
Carol Schleif, chief market strategist at BMO Private Wealth, indicates that the bond market is particularly vigilant this year, especially in light of Moody's downgrade. “As Congress debates the Big Beautiful Bill, bond vigilantes will be monitoring fiscal policies closely,” she remarked, referring to investors who penalize governments with high borrowing costs for poor financial management.
The downgrade from Moody's, following similar actions from Fitch in 2023 and Standard & Poor's in 2011, is expected to lead to increased borrowing costs for both the public and private sectors in the United States. Spencer Hakimian, founder of Tolou Capital Management, pointed out that the implications of this downgrade could reshape the market landscape, pushing investors to adopt a more cautious approach.
However, Gennadiy Goldberg, head of U.S. rates strategy at TD Securities, suggests that while forced selling from funds restricted to investing in top-rated securities is unlikely, the situation will refocus attention on fiscal policy as the contentious bill continues to be negotiated in Congress.
Scott Clemons, chief investment strategist at Brown Brothers Harriman, raises critical questions about the level of pushback expected in Congress regarding fiscal responsibility. He warns that a bill perceived as promoting excessive spending could discourage investors from increasing their exposure to long-dated Treasuries.
Moody's has criticized successive administrations for failing to address the rising trend of fiscal deficits and higher interest costs, casting doubt on the potential for significant deficit reductions from the proposed fiscal measures.
Anthony Woodside, head of fixed income strategy at Legal & General Investment Management America, noted that the recent uptick in the 10-year Treasury term premium reflects growing concerns about fiscal sustainability. Market sentiment appears skeptical about any meaningful reduction in the federal deficit.
Treasury Secretary Scott Bessent has emphasized the administration’s focus on controlling benchmark 10-year yields, which are currently at 4.44%, slightly lower than levels seen before President Trump took office. Nonetheless, experts like Garrett Melson, portfolio strategist with Natixis Investment Managers Solutions, highlight that a significant rise in the deficit could trigger substantial reactions in yields.
The White House has sought to downplay the significance of the Moody's downgrade. Harrison Fields, special assistant to the President, dismissed the concerns, asserting that skeptics were incorrect regarding the impacts of Trump's tariffs, which he claims have led to substantial investments and job growth without triggering inflation.
Despite differing opinions, some market analysts believe that the fiscal outlook may improve as a result of the proposed tax package, which could yield higher tariff revenues and spending offsets. Barclays has revised its projections, estimating that the new bill could increase deficits by $2 trillion over the next decade, a decrease from earlier projections of $3.8 trillion.
As critical deadlines approach, urgency is mounting. House Speaker Mike Johnson aims for the House to pass the Big Beautiful Bill before the Memorial Day holiday on May 26. Meanwhile, Bessent has urged Congress to raise the federal government’s debt limit by mid-July, as the government has already reached its statutory borrowing limit and begun employing extraordinary measures to prevent breaching the cap.
The deadline for a potential cash shortfall is anticipated by August, raising investor concerns regarding the debt limit. Notably, the average yield on Treasury bills maturing in August has surpassed yields on bills with adjacent maturities, signaling growing unease among investors.
While there is consensus within the Republican Party to extend Trump's 2017 tax cuts, divisions remain over how to implement spending cuts that would offset revenue losses. With mandatory spending, including social welfare programs that Trump has pledged to protect, making up a significant portion of the budget, the path toward a politically viable fiscal package appears fraught with challenges.
Experts like Michael Zezas from Morgan Stanley project that any forthcoming fiscal package will likely result in wider deficits in the short term, failing to provide a substantial boost to the economy. Anne Walsh, chief investment officer at Guggenheim Partners Investment Management, emphasizes that without a genuine effort in Washington to reset spending levels, meaningful improvement in the U.S. fiscal trajectory remains unlikely, describing the current course as unsustainable.
