In the latest in a flow of bad news for the United States, Moody’s has cut its rating for the country down one notch to Aa1 from Aaa – the first rating downgrade for the US since August 2023 when Fitch lowered its rating to AA+.
Prior to that, Standard and Poor’s was the first agency to move the US below AAA, back in 2011. Moody’s US rating is now aligned with that of S&P and Fitch.
At Aa1, Moody’s US rating is now at par with that of Finland and Austria, and below that of Australia, Canada, Germany or Switzerland, among others.
Moody’s has highlighted the debt and fiscal risks as the key rationale behind its rating downgrade.
In Moody’s view, the fiscal risks have risen considerably, with the US now showing much higher government debt and interest payment ratios than similarly rated sovereigns.
In the absence of credible fiscal adjustment, Moody’s believes that budget flexibility will remain limited, given the growing weight of mandatory spending, including interest expense.
On this basis, Moody’s projects the fiscal deficit to continue to widen, possibly reaching nearly 9% of GDP by 2035, up from 6.4% in 2024, driven mainly by increased interest payments on debt, rising entitlement spending, and relatively low revenue generation.
Meanwhile, the federal debt burden would rise to about 134% of GDP by 2035, compared to 98% in 2024.
“Moody’s rating action is likely to reinforce the ongoing market theme around the US risk premium,” said Benoit Anne, senior managing director at the strategy and insights group of US-based asset manager MFS Investment Management. “To be clear, Moody’s action has not told us anything that global investors did not already know.
“In addition, Moody’s rating move is technically a late catch-up with its peers,” Anne added. “The risk premium on the US has indeed risen over the past few months, reflecting the elevated trade-policy uncertainty and investors’ concerns over the credibility of the policy framework.”
Market surprise
Although given the rise in US treasury bond yields in response to the downgrade, “markets were still surprised by the move”, said Naomi Fink, chief global strategist at Japanese asset manager Nikko AM, “which interrupted an otherwise hope-fueled rally in US stocks, underpinned by the stability of long-term US bond yields.”
In the near term, it is possible that this new headline further erodes global investors’ appetite towards US assets, Anne said.
“We have already observed a major global rotation away from the US to Europe and other markets since the beginning of the year, a theme that remains relevant for the remainder of 2025,” he said.
Using a framework of contingent probability to interpret the bond market’s reaction to the Moody’s downgrade, yields remain consistent with the upper end of a so-called détente scenario, and the lower end of a stagflation scenario, Fink said.
But she added: “Given the high likelihood that bond yields are an important part of the US’ payoffs in the ongoing tariff negotiations, it is possible that a further rise in US yields, which may imply a more stagflationary expectation from the market, could influence Washington’s policy choices, potentially prompting a shift toward greater ‘détente’ in response to fears of disruptions in the bond market.”
The rates and currency markets are potentially exposed to this new headline shock.
On this, Anne added: “In sharp contrast to the market response to S&P’s surprising rating action in 2011, we do not anticipate that Unites States treasury (UST) yields will decline, reflecting a flight to quality. This is because the UST market has not been able to offer the same defensiveness as it used to in the face of a risk aversion shock.”
This was particularly obvious in April when some global market turbulence surfaced in the wake of the tariff announcement.
“With that in mind, we believe that the rating move may accentuate the upside risks to UST yields, although we do not believe that the Moody’s rating action will turn out to be a major market-moving event,” Anne said.
On the currency side, the US dollar has already been under considerable downward pressure. “We anticipate that the downside risks will continue to predominate in the period ahead,” Anne said.
Finally, should US treasury yields happen to settle at a higher level, this could ultimately represent a risk for equity market valuations.
Investors will be watching.
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