Bond Investors Detect Trouble in US Debt Stripped of AAA Rating

Economic

Bond

Summary:

While the Moody’s decision was anticipated given the flood of red ink in Washington, and it trailed moves from the likes of S&P Global Ratings, investors responded by lifting the yield on US 30-year bonds above 5%.

Even before talk of fresh unfunded tax cuts took center stage in the budget wrangling on Capitol Hill, US bond investors were making their views loud and clear: If the government keeps spending more than it takes in, there will be consequences.

Sure enough, one blow landed late Friday, when Moody’s Ratings revealed it had run out of patience and was lowering its credit score on the world’s biggest borrower below the top triple-A level. It cited a years-long pattern of rising debt and budget deficits, which show no sign of abating amid deeply-rooted political polarization.

That reinforces what many in financial markets have been highlighting: Unless the US gets its finances in order and soon, the perceived risks of lending to the government will increase, and borrowing costs on long-term Treasury debt will climb even further. That would make reducing the deficit even harder and lift the cost of money for households and companies throughout the economy.

“This is a reminder that it is expensive to kick the fiscal can down the road,” said Priya Misra, portfolio manager at JPMorgan Asset Management, after the downgrade on Friday.

The yield on the 10-year note is up about a third of a percentage point this month alone. Embedded in the market is a rise in the premium investors demand to shoulder the risk of owning longer-term US debt. But even shorter-term securities due in two years or less are yielding more than 4%.

“The bond market is skeptical that the Trump administration and Republicans will offset some of the deficit challenges,” said Michael Arone, chief investment strategist at State Street Global Advisors. What this means is that “rates will remain higher and more volatile” than some investors currently expect, he said.

Markets have a history of being the arbiter of fiscal discipline for spendthrift countries, and the recent spike in yields is beginning to echo past instances when so-called bond vigilantes wielded their power in protest of profligacy. The theory goes that if investors impose higher borrowing costs, governments eventually bow to the pressure and retrench.

This time, though, the stakes are much higher. Even though America’s premier position in global finance is still secure, the government faces less borrowing flexibility at a time when international demand for Treasuries — and the US dollar — is increasingly in doubt.

Moody’s flagged a decline in “debt affordability” and identified higher Treasury yields as a factor hurting US fiscal sustainability. A walk through the numbers reveals what it means by this concept, and explains why doubts around the sustainability of US debt have become a regular talking point among investors, central bankers and financiers from Jamie Dimon to Warren Buffett.

While current US yields between 4% and 5% are near levels that prevailed before 2007 and the financial crisis — and the US historically has paid far higher rates at times — debt and deficits now are exponentially bigger, and that makes all the difference.

A then-and-now look at the fiscal landscape since 2007 reveals a staggering transformation. The amount of outstanding Treasuries has skyrocketed from $4.5 trillion to nearly $30 trillion today — a reflection of the explosion in borrowing during Covid. Annual gross sales of government debt have also ballooned, from $362 billion in 2007 to $2.6 trillion last year, according to Sifma, the bond market’s trade group.

More alarmingly, the ratio of total US public debt to the size of the economy has risen from about 35% in 2007 to 100% now, according to the Congressional Budget Office. Interest payments alone were about $880 billion in 2024, CBO data show.

Enter the budget talks, and a deficit in the trillions running at 6.5% of the economy appears entrenched as tax cuts backed by President Donald Trump loom in Washington’s latest spending plan without sufficient offsetting cost cuts or revenue to pay for them. Trump is pushing for the budget bill’s passage even as hardline Republicans bristle at the prospect of wider gaps.

“The current plan that they’re putting forward is not going to make a material reduction in the deficit in my view,” said David Rogal, portfolio manager of fundamental fixed income group at BlackRock Inc. and a member of the Treasury Borrowing Advisory Committee, an elite group of bond market participants. “The funding gaps open up next year and the year after, where there’s close to $2 trillion if the deficit stays on its current course. How we deal with that is going to be very important.”

The precarious nature of the situation isn’t lost on US Treasury Secretary Scott Bessent, who acknowledged to US lawmakers earlier this month that the nation’s debt path is unsustainable. He also indicated an awareness of the power of the bond vigilantes, adding it’s “very difficult to know” the tipping point at which investors would “rebel.”

As for the downgrade, Bessent told NBC’s Meet the Press on Sunday that “Moody’s is a lagging indicator — that’s what everyone thinks of credit agencies,” and lambasted the spending under the Biden administration.

But Moody’s said its action reflected not just excessive spending during successive administrations, but a bleak outlook for the fiscal picture and the expectation for “larger deficits as entitlement spending rises while government revenue remains broadly flat.”

Without political will to rein in spending in a meaningful way, and no guarantee that tax cuts will goose the economy enough to allow the government to grow out of its debt problems, Bessent will have to hope that a tipping point into rebellion doesn’t occur anytime soon in the bond market.

Already, there have been rumblings from investors like Eurizon SLJ Capital’s Stephen Jen that a bond-market blowup may be needed to force real progress on fixing the budget.

What Bloomberg Strategists Say...

“Moody’s decision underscores deeper structural concerns. The risk is that bond vigilantes re-emerge, pushing yields higher as term premiums adjust to the new fiscal reality. That could weigh on equity valuations and rekindle broader doubts over the resilience of US assets.”

— Mary Nicola, Macro Strategist

In the meantime, the Treasury is walking a fine line as investors grow wary of taking on long-term securities and are turning instead to debt with shorter maturities. For an agency that seeks the lowest financing cost over time and extols a regular and predictable approach, the response has been one of selling more short-term debt, where there is better demand.

“It’s a very delicate balance between how much you can issue further out in the long end relative to demand,” said John Madziyire, senior portfolio manager at Vanguard. “And I’ll say that’s one of the things that limits how far out the Treasury can issue.”

Bessent has maintained the same debt mix as his predecessor Janet Yellen, who moved toward selling more bills following a bond-market tempest in late 2023. That has lowered the average maturity of the government’s IOUs. The result: increased hazards around smoothly rolling over big amounts of debt as it comes due, especially in another debt-ceiling standoff scenario, and a situation that creates a point of vulnerability.

“The more you have to roll over and the more politicized the debt ceiling is, the more risk you’re putting into the system,” said Greg Peters, who helps manage more than $850 billion as co-chief investment officer at PGIM Fixed Income and is also a TBAC member.

Of course, the US is unique compared with other countries in having a vast money market industry rather than relying on bank savings accounts. The current stash of nearly $7 trillion in these funds means there is a regular buyer of Treasury bills that extends from four weeks to 12 months. That funding mix provides Treasury with a lot of wiggle room, but the longer Treasury yields remain in a 4%-plus zone, the cost of rolling over a growing debt pile keeps rising.

“Now Scott Bessent’s Treasury Department is funding short rather than long and you have huge refinancing obligations,” James Millstein, co-chairman at Guggenheim Securities and a former US Treasury official, told Bloomberg TV on Monday.

The debt problem and the expectation among watchdogs including the CBO that US entitlement spending will only shoot higher in the years ahead leaves the Treasury with little choice but to retain its current funding mix and wait for a window of lower longer-dated yields.

“Ultimately the issuance strategy can help, but the big picture will depend on whether the budget deficits themselves are improving,” said Guneet Dhingra, head of US interest-rate strategy at BNP Paribas.

For now, the US has still has scope to manage its debt should lawmakers continue to run up deficits. An investor standoff that forces a yield surge beyond 5% would likely encourage other long-term natural buyers such as pension funds and insurers to step in. Even in the case of an unruly rise in bond yields or messy auction, market participants said it’s likely that the Federal Reserve would intervene and buy Treasuries as a backstop.

“If you had a really sloppy auction, say a 30-year or 10-year, and the bond market really got unsettled, then I think at that point the Fed would probably step in,” said Jurrien Timmer, director of global macro at Fidelity Investments. “It’s part of the Fed’s job to maintain orderly markets.”

Zooming out from a historical perspective, though, the US has already breached a worrisome threshold. Historian and former Bloomberg Opinion contributor Niall Ferguson cites a different type of tipping point: When the cost of paying interest exceeds US defense spending, that puts a great power’s influence in jeopardy. This already happened in the US last year.

“Debt is a problem, but you know, what is even more of a problem is not addressing it,” said Sinead Colton Grant, chief investment officer at BNY Wealth.

Source: Bloomberg

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

You understand and acknowledge that there is a high degree of risk involved in trading. Following any strategies or investment methods may lead to potential losses. The content on the site is provided by our contributors and analysts for information purposes only. You are solely responsible for determining whether any trading assets, securities, strategy, or any other product is suitable for investing based on your own investment objectives and financial situation.

Add to Favorites

Adam

Economic

Oil prices have staged a decent recovery as the day has progressed following renewed demand concerns to start the week. Oil prices faced pressure on two fronts in early trade as lackluster retail sales data from China weighed on sentiment.

Chinese Data and Moody’s Downgrade

Retail sales, which reflect consumer spending, grew by 5.1% in April, slowing from 5.9% in March and falling short of the 5.5% forecast. Economists blame the slowdown on U.S. tariffs affecting consumer confidence and weak domestic demand.

This was further compounded by a Moody’s downgrade of the United States from AAA to Aa1, raising concerns around the US economic outlook. This comes after last week's US data hinted at a potential slowdown. Consumer confidence data from the US also painted a dour picture, however there does appear to be some room for optimism.

Goldman Sachs Raises Oil Demand Outlook

With demand concerns returning to the fore Goldman Sachs decision to increase its global oil demand forecast came at a perfect time and may have mitigated some selling pressure.

Goldman Sachs analysts have raised their forecast for global oil demand, predicting an increase of 600,000 barrels per day this year and 400,000 barrels per day in 2026.

Despite this, the bank kept its oil price predictions unchanged at $60 per barrel for Brent crude and $56 per barrel for West Texas Intermediate (WTI) for 2025. Currently, Brent crude is trading above $65 per barrel, and WTI is over $62.

Goldman Sachs raised its oil demand forecast, citing optimism about a potential trade war resolution and a US-Iran nuclear deal.

However, the Investment Bank warned that if the tariff war continues and harms the global economy, Brent crude prices could fall to $40 per barrel by late 2026. This would also require OPEC+ to fully restore the supply cuts made in 2022, according to the analysts.

So a slight ray of hope where demand is concerned but the prices discussed in the Goldman note raises affordability concerns particularly for US Oil producers. The $56 a barrel mark has been touted by some as a break-even point for US producers, with a drop below this price level likely to affect production and output. Interesting times for Oil markets and a potentially bumpy ride ahead.

Technical Analysis - Brent Crude

From a technical standpoint. Brent crude posted a bullish inside bar close on Friday.

This is usually a hint at further upside something which has materialized as the day progressed.

As things stand, the Oil price approaching a resistance level at 66.42 with a break of the previous high potentially leading to a retest of resistance at 68.17.

The period-14 RSI on the daily timeframe has also crossed back above the 50 neutral level which signals a shift in momentum from bearish to bullish.

If however bears are to return and push prices lower, immediate support rests at 65.00 and 64.00 before the 62.81 handle comes into focus.

Brent Crude Oil Daily Chart, May 19, 2025

Client Sentiment Data - WTI Oil

Looking at OANDA client sentiment data and market participants are Net-Long on WTI with 74% of traders holding long positions. I prefer to take a contrarian view toward crowd sentiment and thus the fact that so many traders are long means WTI prices could decline further.

Source: marketpulse

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

Add to Favorites

Manuel

Economic

U.S. consumer sentiment deteriorated further in May, with one-year inflation expectations soaring to levels last seen in late 1981 amid escalating fears over the economic impact of President Donald Trump's trade policy.

The University of Michigan's Surveys of Consumers on Friday showed a significant decline in morale among Republicans, suggesting that even Trump's base was becoming concerned with the president's sweeping tariffs, which this week led retail giant Walmart to warn that it would start raising prices at the end of month because of increased costs from import duties.

It was the first time that sentiment dropped among Republicans since Trump's November 5 electoral victory. The continued slump in overall sentiment and jump in inflation expectations suggested a retrenchment in consumer spending was probably underway that could temper economists' expectations for a rebound in economic growth this quarter. US Consumer Sentiment Slumps, Households Brace for Inflation Surge_1

US Consumer Sentiment Slumps, Households Brace for Inflation Surge_1

The economy contracted in the first quarter for the first time in three years amid a flood of imports as businesses tried to beat the higher costs associated with tariffs. Retail sales were almost flat in April.

"The consumer is plainly worried and reading between the lines it is not just price increases that are worrying, it is the fact that many goods may be impossible to find as the reduction in port activity means shortages could develop within months," said Christopher Rupkey, chief economist at FWDBONDS.

"The outlook continues to darken and one wonders how long this can continue before the economy actually slips over the edge into recession."

The University of Michigan's consumer sentiment index dropped to 50.8 this month, the lowest level since June 2022, from a final reading of 52.2 in April. Economists polled by Reuters had forecast the index would rise to 53.4.

Sentiment dropped 7% among Republicans, offsetting an improvement among independents. The mood remained gloomy among Democrats.

The survey was conducted between April 22 and May 13, wrapping up two days after the U.S. and China de-escalated their trade war. Duties on Chinese imports were slashed to 30% from 145% for 90 days as part of the deal reached last weekend by Washington and Beijing.

The University of Michigan said the initial reaction mirrored the minor improvement in sentiment seen following the delayed implementation in April of Trump's country-specific duties until July.

"Tariffs were spontaneously mentioned by nearly three-quarters of consumers, up from almost 60% in April; uncertainty over trade policy continues to dominate consumers' thinking about the economy," said Joanne Hsu, the Surveys of Consumers director. "Consumers continue to express somber views about the economy."

Consumers' 12-month inflation expectation soared to 7.3%, the highest level since November 1981, from 6.5% in April. Both Democrats and Republicans anticipated higher near-term inflation. The jump pointed to higher prices in the months ahead despite benign consumer prices in April, which economists attributed to businesses still selling inventory accumulated ahead of tariffs.

PRICE HIKES LOOMING

Auto manufacturers also have announced price increases, and economists expect inflation to pick up by the middle of this year. Long-run inflation expectations increased to 4.6% in the University of Michigan data, the highest level since March 1991, from 4.4% in April amid a large jump among Republicans. Rising inflation expectations could complicate matters for the Federal Reserve as it weighs its next monetary policy move.

"The key idea to remember here is that inflation expectations are the primary transmission mechanism, along with external retaliation, that turns tariffs into a sustained increase in the price level or inflation," said Joseph Brusuelas, chief economist at RSM US. "The idea that the Federal Reserve is going to hike rates anytime soon should be summarily dismissed."

Fed Chair Jerome Powell warned on Thursday that "we may be entering a period of more frequent, and potentially more persistent, supply shocks - a difficult challenge for the economy and for central banks. The U.S. central bank left its benchmark overnight interest rate in the 4.25%-4.50% range earlier this month.

Higher inflation was flagged in a separate report from the Labor Department's Bureau of Labor Statistics that showed prices for imported capital goods jumped 0.6% in April, while those of consumer goods excluding motor vehicles increased 0.3%. Overall import prices, which exclude tariffs, gained 0.1% after falling 0.4% in March. The reading confounded economists' expectations for a 0.4% decline. US Consumer Sentiment Slumps, Households Brace for Inflation Surge_2

US Consumer Sentiment Slumps, Households Brace for Inflation Surge_2

"Our tariff pass-through analysis indicates that costs are still largely being borne by U.S. importers," said Pooja Sriram, an economist at Barclays. That is at odds with the White House's narrative.

Tariffs are also weighing on activity in the housing market.

A separate report from the Commerce Department's Census Bureau showed single-family housing starts, which account for the bulk of homebuilding, dropped 2.1% to a seasonally adjusted annual rate of 927,000 units last month, the lowest level in nine months. Permits for future construction of single-family housing declined 5.1% to a rate of 922,000 units, suggesting the weakness might persist. There is also a glut of unsold new homes on the market.

Indeed, a National Association of Home Builders survey on Thursday showed sentiment among single-family homebuilders plunged to a 1-1/2-year low in May, with 78% of builders reporting "difficulties pricing their homes recently due to uncertainty around material prices."

"Builders are hitting the brakes this year in response to high uncertainty for costs and future demand," said Ben Ayers, a senior economist at Nationwide. "We expect starts to fade further over the summer as conditions remain challenging for builder profitability." US Consumer Sentiment Slumps, Households Brace for Inflation Surge_3

US Consumer Sentiment Slumps, Households Brace for Inflation Surge_3

Source: Reuters

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

Add to Favorites

Owen Li

Political

Presidents Trump and Putin have ended their phone call, which lasted for more than two hours, according to RIA. This suggests some heavy lifting was done regarding peace in Ukraine, and restoring Washington-Moscow relations. Trump had reportedly phoned Zelensky just prior to speaking with Putin. It appears an overall 'positive' development, also given the emerging wire headlines:

PUTIN CALLED HIS CONVERSATION WITH TRUMP USEFUL: TASS
PUTIN: MEMORANDUM WITH UKRAINE MAY INCLUDE TRUCE TERMS: TASS
RUSSIA READY TO WORK WITH UKRAINE ON FUTURE PEACE DEAL: TASS
PUTIN SAYS HIS CONVERSATION WITH TRUMP WAS VERY MEANINGFUL: IFX
PUTIN SAYS TRUCE IS POSSIBLE IF CERTAIN AGREEMENTS REACHED:TASS

But this Putin reference to "certain agreements" or conditions being reached will be the sticking point. Zelensky has repeatedly made clear "this is Ukraine's land" when it comes to the annexed four eastern territories and Crimea.

Very likely, Putin pressed this point with Trump - that Zelensky is refusing any level of compromise (which is precisely what Kiev is currently accusing Moscow of doing).

As we await the call readouts from both sides, Vice President JD Vance's latest remarks upon returning to the US from Rome lay out where things stand:

President Trump is expected to hold a phone call with Russian President Vladimir Putin on Monday, followed by a call with Ukrainian President Volodymyr Zelensky - after they were first announced Saturday.

Writing in all caps, the president posted over the weekend to Truth Social, "The subjects of the call with be, stopping the 'bloodbath' that is killing, on average, more than 5000 Russian and Ukrainian soldiers a week, and trade."

He continued in the statement by saying "hopefully it will be a productive day, a ceasefire will take place, and this very violent war, a war that should have never happened, will end." His highly optimistic note ended with "God bless us all!!!" - again written in all caps.

Trump has further indicated he'll be in contact with "various" NATO leaders related to these ceasefire efforts, coming on heels of the Friday meeting between Russian and Ukrainian delegations - the first such direct engagement since efforts at talks ceased within the opening months of 2022 and the war's start.

The NY Times has previewed:

The call, which Mr. Trump said would take place at 10 a.m. Eastern, would be the third known phone conversation between the two men since the American president’s second term began. The first two, which took place in February and March, were celebrated in Moscow as signs of weakening Western resolve to isolate and punish Russia for its invasion of Ukraine.

And the Kremlin issued the following Monday:

"The conversation is important, taking into account the negotiations held in Istanbul," Peskov said. "As for the talks, we [in the Kremlin] have already said everything we could, we underscored the basic points," he added. "We will now wait for it. We will give the maximum information possible based on the results of the conversation," he stated.

There was little concrete which came out of the meeting, other than a new POW swap - which is to involve 1,000 captives returned on either side - and declarations that each side is open to meeting a gain.

Still, the warring sides are far apart in terms of conditions, with Zelensky having reasserted on Friday, "In all discussions – and I emphasize this – and this is my unwavering position – we do not legally recognize any of our temporarily occupied territories as Russian. This is the Ukrainian land."

Just ahead of the Putin-Zelensky calls at the White House on Monday:

Meanwhile, Secretary of State Marco Rubio revealed the US administration's thinking on how things are really going at this point. He reiterated to CBS News’ ‘Face the Nation’ on Sunday that the White House will not tolerate endless negotiations which simply drag the war and killing on further.

"On the one hand, we’re trying to achieve peace and end a very bloody, costly, and destructive war. So there’s some element of patience that is required," he began by acknowledging.

"On the other hand, we don’t have time to waste. There are a lot of other things happening in the world that we also need to be paying attention to. So we don’t want to be involved in this process of just endless talks. There has to be some progress, some movement forward," he then emphasized.

The US is currently examining competing ceasefire proposals offered by each side. "If those papers have ideas on them that are realistic and rational, then I think we know we’ve made progress," he said.

The following is reportedly among Moscow's top list of demands, which can be described as maximalist (at least from the West's perspective), per a recent Bloomberg report:

Ukraine agreeing to neutral status regarding NATO
No foreign troops in Ukraine
No nuclear weapons in Ukraine
De-facto recognition of Crimea and lost eastern territories as now Russia's
Withdrawal of Kiev forces from these territories before a ceasefire takes effect

But Ukraine has rejected the Kremlin's demand of de-facto recognizing the loss of its territories. Zelensky has time and again vowed to fight on, despite mounting losses and serious manpower issues.

The White House is likely to latch on to anything positive regarding these talks that it can; however, President Trump has clearly been exerting pressure for more speedy resolution, and is growing impatient.

The Europeans are ready to slap more sanctions on Moscow, and Washington has also warned that this would essentially be plan B if Russia doesn't cooperate. But Russia's fresh maximalist demands will be a hard sell.

Source: Zero Hedge

Risk Warnings and Disclaimers

Add to Favorites

Adam

Economic

This morning, markets are reacting to Moody’s rating downgrade of U.S. debt. For those promoting egregious amounts of “bear porn,” this is nirvana for fear-mongering headlines that gain clicks and views. However, as investors, we need to step back and examine the history of previous debt downgrades and their outcomes for both the stock and bond markets. Let’s start with what the Moody’s rating agency stated about its rating change.

“This one-notch downgrade on our 21-notch rating scale reflects the increase over more than a decade in government debt and interest payment ratios to levels that are significantly higher than similarly rated sovereigns.”

Moody’s had been a holdout in keeping U.S. sovereign debt at the highest credit rating possible, and brings the 116-year-old agency into line with its rivals. Standard & Poor’s downgraded the U.S. to AA+ from AAA in August 2011, and Fitch Ratings also cut the U.S. rating to AA+ from AAA in August 2023. We will review these previous downgrades momentarily. However, the reason for Moody’s debt downgrade is unsurprising.

“Successive U.S. administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs. We do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration.”

It is that last sentence that is the most important. Since 2008, the U.S. has not passed a single budget. Instead, Congress has repeatedly opted for short-term funding bills, known as Continuing Resolutions (CRs), which raised the debt ceiling and increased spending by 8% annually. (The “Rule of 72” says that at that rate, spending will double every 9 years) Such is why the national debt, specifically the deficit, has continued to grow unabated. Such was a point we discussed in Why $32 Trillion Matters.

“While Washington continues a seemingly unbridled spending spree under the assumption “more spending” is better, debts and deficits matter. To better understand the impact of debt and deficits on economic growth, we must know where we came from. The chart shows the 10-year annualized growth rate of the economy over time.“

Moody’s Debt Downgrade — Does It Matter?_1

What should immediately jump out at you is that the 10-year average economic growth rate was around 8%, except for the Great Depression era, from 1900 through 1990. However, there has been a marked decline in economic growth since then. Unsurprisingly, as debts and deficits grow, the diversion of capital from productive activities to debt service erodes economic growth. That growth in debt is on a non-stop train to “Japanification,” where debt continues to rise, and economic growth is anemic. The Congressional Budget Office recently released its trajectory for U.S. debt levels through 2055, showing the same.

Moody’s Debt Downgrade — Does It Matter?_2

(The debt is also why interest rates can not rise to higher levels, which is a topic of an upcoming article on why we continue to buy Treasury bonds.)

While a debt downgrade is notable, there are several things that investors must consider.

This is not the first time that U.S. debt has been downgraded. (We will review this momentarily.)

The debt downgrade does nothing to impair the reserve currency status of the US dollar.

The U.S. Treasury remains the gold standard for “risk-free” investment for foreign and domestic savers.

However, most importantly, for investors, is the debt downgrade as ominous and bearish headlines suggest?

Let’s review previous history and see how stock and bond markets reacted.

S&P Downgrades US Debt

“Credit rating agency Standard & Poor’s on Friday downgraded the United States’ credit rating, stripping the world’s largest economy of its prized AAA status.

In July, S&P placed the United States’ rating on “CreditWatch with negative implications” as the debt ceiling debate devolved into partisan bickering. To avoid a downgrade, S&P said the United States needed to raise the debt ceiling and develop a “credible” plan to tackle the nation’s long-term debt.

In its report Friday, S&P ruled that the U.S. fell short: “The downgrade reflects our opinion that the … plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.”

S&P also cited dysfunctional policymaking in Washington as a factor in the downgrade. “The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed.” – CNN.Com

That action occurred on August 5th, 2011, as the Obama Administration faced Congress over the debt ceiling debate. Unsurprisingly, just as today, headlines were rampant with fearmongers ramping up the rhetoric about a dollar collapse, the economy’s demise, and the stock market’s collapse. While I am certainly not dismissing the issues with the debt buildup long-term, as noted in the linked article above, in the short term, history suggests there is much less to worry about in the near term.

Let’s take a look at 2011 for a moment in charts. The first chart below is the stock market. As you will note, much like the advance we witnessed over the last few months, the market had rallied sharply from the lows in 2010 and was pretty overbought at the time of the debt downgrade.

Moody’s Debt Downgrade — Does It Matter?_3

Likewise, in 2011, the yields on treasury debt also spiked higher temporarily as the debt downgrade shook investors. However, given that the U.S. treasury bond market remains the world’s preferred “safe haven,” yields declined into 2012. As is always the case, long-duration yields are a function of inflation and economic growth. The more debt issued, the slower the economic growth rate over time. Many “bond gurus” expect yields to spike sharply due to the need for debt issuance. However, the reality is that the economy can’t sustain higher rates because of the debt. What happened in 2011 will likely repeat itself in the months and quarters ahead as economic growth continues to slow.

Moody’s Debt Downgrade — Does It Matter?_4

What happened the second time?

Fitch Downgrades U.S. Debt

On Tuesday, August 1st, 2023, almost exactly 12 years later, Fitch downgraded the U.S. credit rating.

“Fitch Ratings has downgraded the United States of America’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘AA+’ from ‘AAA’. The Rating Watch Negative was removed and a Stable Outlook assigned. The Country Ceiling has been affirmed at ‘AAA’.

What was Fitch’s reasoning for the downgrade?

“The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.”

Interestingly, the Treasury Department pushed back, saying the “analysis was flawed” in both cases.

“Janet Yellen, the US treasury secretary, said she disagreed with Fitch’s downgrade, in a statement that called it “arbitrary and based on outdated data.” – The Guardian

As with S&P’s debt downgrade, the reasons behind Fitch’s action were almost identical. They focused on the Government’s inability to deal with long-term debt issues.

However, as Yellen noted, the analysis is flawed on many levels. Such was a point made by Jamie Dimon, CEO of J.P. Morgan:

“It doesn’t really matter that much” because it’s the market, not rating agencies, that determines borrowing costs. Still, it’s ridiculous that other countries have higher credit ratings than the U.S. when they depend on the stability created by the U.S. and its military. To have them be triple-A and not America is kind of ridiculous. It’s still the most prosperous nation on the planet, it’s the most secure nation on the planet.”

While the long-term implications are dire, the near-term impact on various assets is much less concerning.

“The U.S. can print money and avoid default no matter how bad its fiscal position is. Accordingly, U.S. Treasury debt will still be considered the world’s only risk-free asset regardless of its ratings. The table below shows the market reactions to the S&P downgrade in 2011. Unexpectedly, bond yields fell appreciably, and the dollar rose, despite the downgrade. One would have thought gold would be a beneficiary. It was initially, but its price was slightly lower a year later. Stocks troughed 8% lower within the first week of the downgrade but were on solid footing afterward. Like twelve years ago, the downgrade may provide opportunities contrary to what many expect.“ – Michael Lebowitz

Much like in 2011, the stock market initially sold off on the news, but it was most driven by a reversal of the “Artificial Intelligence Trade” that had gotten ahead of itself. The debt downgrade had much less to do with the correction than providing a catalyst to reverse the overbought conditions that existed at the time.

Moody’s Debt Downgrade — Does It Matter?_5

The bond market also sold off initially with higher yields, but this quickly reversed. While yields are currently elevated due to stronger economic growth rates, higher inflation, and tighter Fed policy, that condition will reverse as continued debt increases weigh on financial prosperity.

Moody’s Debt Downgrade — Does It Matter?_6

For evidence of such an outcome, we only have to look at Japan to understand the consequences of debt when it exceeds 100% of GDP. Since the 1980s, Japan’s economic trajectory has remained lower. Despite massive Government and central bank interventions, interest rates remain near zero percent as the economy experiences rolling recessions, plaguing overall prosperity. (As of the end of 2024, economic growth was barely positive with bond yields below 1%)

Moody’s Debt Downgrade — Does It Matter?_7

So the question facing investors is, should we care that Moody’s downgraded the debt?

Moody’s Downgrade – What It Means For Stocks & Bonds

With Moody’s debt downgrade, media headlines are running wild with speculation about what it means. As we have seen in the previous two downgrades, it has not meant much. Almost 15 years after S&P’s downgrade of the debt, the U.S. remains the world’s reserve currency, gold vastly underperformed equities, and the economy didn’t collapse under the weight of the debt. On the contrary, investors have been well rewarded betting against those outcomes.

Moody’s Debt Downgrade — Does It Matter?_8

However, is this time different? Most likely, the answer is “no.” Therefore, what should investors expect from stocks and bonds over the next several months following Moody’s downgrade?

Concerning the stock market, we went into the downgrade with stocks back in overbought territory after a significant advance from the “Liberation Day” lows. As shown, momentum and relative strength are overbought, especially momentum, with the market now two standard deviations above the 50-DMA. If you review the charts above, the market was in a very similar position during the previous announcements, leading to a short-term correction in equity prices.

As is always the case, when markets aggressively advance, it often takes an external, unexpected event to bring sellers into the market. Such would also be unsurprising if that were the case this time. However, most likely, such will be an opportunity for investors to add equity exposure.

Moody’s Debt Downgrade — Does It Matter?_9

Likewise, while not as overbought as equities, yields have pushed higher into the announcement. As seen in the previous two downgrades, yields did go higher on the news, but eventually, the fundamentals that drive yields (economic growth, wages, and inflation) reversed yields lower.

Moody’s Debt Downgrade — Does It Matter?_10

As we noted this past week, this is particularly true as US bank regulators prepare to reduce bank capital requirements.

“Of particular interest to the bond market is the supplementary leverage ratio, better known as SLR. Unlike other risk-based capital rules that banks adhere to, SLR applies a minimum capital requirement to all bank balance sheet assets. The rule was put in place in 2014 to limit excessive leverage. (More from the Office of Financial Research.)

Banks have long argued that the SLR handcuffs their ability to make loans. Furthermore, and of importance to the administration, banks claim that SLR limits their ability to buy Treasury securities. The article states that intense lobbying from Wall Street argues that SLR hinders competition and impedes lending. Remember that the eight largest US banks are subject to enhanced SLR, which are the biggest buyers of US Treasury securities.

Many analysts suspect that the SLR will change by this summer. However, the pressure to change them sooner could arise if Treasury yields continue to rise. With Treasury yields approaching 5%, we suspect banks will be licking their chops to buy Treasuries once the SLR restrictions are eased.”

Given the massive short position on U.S. Treasuries, bond buyers could see a significant drop in yields and a rise in bond prices, particularly if this coincides with the onset of a recession or Fed rate-cutting cycle.

Moody’s Debt Downgrade — Does It Matter?_11

Conclusion – Opportunity Likely Coming

From a portfolio management perspective, the debt downgrade does nothing to change our outlook. Investor demand and significant corporate share repurchases will likely continue to provide a bid under equities. However, we will not be surprised to see a pullback, which the media will quickly blame on Moody’s debt downgrade. However, given the short-term overbought conditions, the downgrade was the catalyst to bring sellers into the market.

Are we concerned about the potential for a recession or some financial event? Of course. Given the aggressiveness of the Fed rate hikes and tightening of lending standards, such an event is certainly possible. Economic growth is slowing, as inflation is falling, which is evidence of a slowing consumer. However, the market will provide advanced notice if we continue to pay attention to our technical indicators.

For now, the longer-term bullish trend remains intact. A correction that holds support and works off some of the overbought conditions will be a healthy outcome. Such will provide better risk/reward opportunities to increase stock and bond exposure.

Technical and sentiment readings suggest the market has gotten ahead of itself over the last few weeks, so investors should consider rebalancing portfolio risk accordingly.

Tighten up stop-loss levels to current support levels for each position.

Hedge portfolios against more significant market declines.

Take profits in positions that have been big winners.

Sell laggards and losers.

Raise cash and rebalance portfolios to target weightings.

Of all the things investors should worry about, the Moody’s debt downgrade is not one of them.

source :investing

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

Add to Favorites

Adam

Stocks

If you are a stock market investor, it’s always a good idea to regularly check in with your portfolio, especially with so many outside forces, both political and economic, influencing the market and your investment decisions. Making changes during times of economic volatility isn’t always a sure-fire decision, but it could be a good time to consider locking in any losses or gains. And according to investing experts, some stocks could be worth dumping all together.

Defense Contractors

Big defense contractors have typically been pretty safe bets in the stock market, although Boeing’s struggles last year during a rising market clearly show that isn’t always the case. Peter C. Earle, senior economist for the American Institute for Economic Research, sees possible trouble ahead for the industry.

“Should the incoming Trump administration follow through on its pledges to force other nations to fend for themselves, the largest publicly traded defense contractors might be poised for a pullback: Lockheed Martin (LMT) and Raytheon (RTX),” Earle said.

Renewable Energy

Earle also sees risk in the green energy sector, noting that the Biden administration’s Inflation Reduction Act provided for a large amount of subsidies for renewables. “If those are reduced or eliminated, many of the solar, wind and alternative energy source firms will be in serious jeopardy. Two of those may include Enphase Energy (ENPH) and NextEra Energy (NEE),” Earle said.

Import-Dependent Firms

Earle also noted that a cornerstone of the Trump administration is tariffs and other forms of trade protectionism — a term for government policies that restrict international trade with the intent of helping domestic industries. Such measures are often controversial because of the unintended consequences that can arise from them.

“If tariffs of the type which have been discussed are put in place — 60%, 100%, 200% and so on — retaliatory tariffs would follow. Those could, in turn, devastate companies that rely on imports: consumer electronics firms, automobile manufacturers, medical device makers and discount retailers. Those could include, among others, Boston Scientific (BSX), Walmart, which imports 70% to 80% of its goods from Chinese suppliers (WMT) and Sony Corporation (SONY),” Earle said.

Discretionary/Luxury Consumer Goods

In an inflationary and high-interest-rate environment, businesses that sell nonessential goods and services are often negatively impacted. Derrick Fung is the CEO of Signals, an investment intelligence platform that analyzes consumer spending trends to help investors anticipate market movements. According to his data, there has been a notable downtrend in these “nice to have” products. In particular, his platform has issued a “sell” signal on stocks like Coty (COTY), Arhaus (ARHS) and Victoria’s Secret (VSCO).

You may not be familiar with fashion and beauty holding company Coty, but you are certainly familiar with their brands. Luxury brands like Burberry, Tiffany and Calvin Klein, as well as consumer brands like Adidas Covergirl all fall under the Coty umbrella. Arhaus is an online and brick-and-mortar retailer of responsibly sourced premium home furnishings. Victoria’s Secret is of course an iconic specialty retailer of lingerie and sleepwear.

“Our data has been showing a downtrend on all the names above. [All of them] are based on the brand being trendy; all of the names have started to lose their appeal either to a competitor (for example, Coty to Elf Beauty, Lululemon to Alo Yoga) or the category as a whole is seeing a secular decline,” Fung said.

Final Take To GO: Exercise Caution

“Predictions have an uncanny knack for making fools of all of us. Other circumstances may arise which make any of all of these projections erroneous or irrelevant,” Earle said. It’s important to remember that predicting the future is hard to do. Be careful that you don’t overreact to trends that are ultimately fairly short-term.

Earle strongly recommends that investors speak with their financial advisor before making any major decisions on whether or not to buy, sell or hold. A professional advisor can help you make the investment moves that are right for your unique situation, regardless of everything happening in 2025 and beyond.

Source: finance.yahoo

Risk Warnings and Disclaimers

Add to Favorites

Adam

Cryptocurrency

Leading cryptocurrency Bitcoin has had a volatile start to the week as it rose 2.5% from $103,850 to $106,500 before slumping 3.8% to $102,450 on Monday.

With Bitcoin’s major moves $178.46 million worth of positions have been liquidated over the past 24 hours, according to CoinGlass, with a fairly equal split between long and short positions.

This comes as a class action lawsuit was filed against MicroStrategy, the firm led by Michael Saylor that is bullishly acquiring Bitcoin, claiming that the firm is misleading investors—a matter of hours later the company announced the acquisition of $764.9 million worth of BTC.

Plus, an Australian judge ruled that Bitcoin is a form of money, according to the Australian Financial Review. That will potentially open the door to Bitcoin being exempt from capital gains tax.

Meanwhile, Ethereum has tumbled 4.3% on the day from $2,500 to $2,400 after what was considered a great month for the second largest cryptocurrency. As such $264.40 million worth of Ethereum positions have been liquidated, according to CoinGlass, with $205.28 million of these being longs.

This follows a month of green action for most of the crypto industry, as President Trump’s trade war appears to be coming to a close.

At the start of May, the U.S. and the UK agreed on a trade deal in what the UK Treasury minister called a “huge relief.” Then, last week, China reached an agreement with the States prompting a major roll back in tariffs between the countries.

However, inflation concerns have resurfaced following the Federal Reserve keeping its benchmark interest rate at 4.25% to 4.50%, with no sign of an immediate shift in policy—despite criticism from Trump. The Fed also warned that the risk of higher inflation and unemployment were rising due to Trump’s tariff war.

These concerns were compounded last week by Walmart announcing plans to raise prices this month, due to the impact that tariffs had on imports.

This may explain why Bitcoin has had such a surprisingly volatile week. It hit a weekly low of $101,750 on Tuesday followed by multiple peaks and troughs before hitting $106,500 high on Monday, and slumping back to $102,450 hours later.

Despite Bitcoin’s 1.4% drop on the day, according to CoinGecko, it remains just 5.8% from its all-time high of $108,786 hit in January of this year. Ethereum, by comparison, is still 50.9% from its all-time high of $4,878 achieved in 2021.