[NEW YORK] Investors faced yet another bumpy start to the trading week with US assets coming under fresh pressure, although it’s mounting concern over American debt rather than tariffs generating the volatility this time.
US equity and bond futures retreated with the US dollar in early Asia trading after Moody’s Ratings announced on Friday (May 16) evening it was stripping the American government of its top credit rating, dropping the country to Aa1 from Aaa. The company, which trailed rivals, blamed successive presidents and congressional lawmakers for a ballooning budget deficit it said showed little sign of narrowing.
The downgrade risks reinforcing Wall Street’s growing worries over the US sovereign bond market as Capitol Hill debates even more unfunded tax cuts and the economy looks set to slow as US President Donald Trump upends long-established commercial partnerships and re-negotiate trade deals.
On Friday, 10-year Treasury yields rose as high as 4.49 per cent in thin volumes.
“A Treasury downgrade is unsurprising amid unrelenting unfunded fiscal largesse that’s only set to accelerate,” said Max Gokhman, deputy chief investment officer at Franklin Templeton Investment Solutions. “Debt servicing costs will continue creeping higher as large investors, both sovereign and institutional, start gradually swapping Treasuries for other safe-haven assets. This, unfortunately, can create a dangerous bear steepener spiral for US yields, further downward pressure on the greenback, and reduce the attractiveness of US equities.”
Michael Schumacher and Angelo Manolatos, strategists at Wells Fargo & Co, told clients in a report that they expect “10-year and 30-year Treasury yields to rise another five to 10 basis points in response to the Moody’s downgrade”.
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A 10-basis point increase in the 30-year yield would be enough to lift it above 5 per cent to the highest since November 2023 and closer to that year’s peak, when rates reached levels unseen since mid-2007.
While rising yields typically boost a currency, the debt worries may add to scepticism over the US dollar. A Bloomberg index of the greenback is already close to its April lows and sentiment among options traders is the most negative in five years.
In April, US markets across the board came under pressure after Trump’s tariff pledges forced a reappraisal of their place at the core of many investor portfolios. The sell-off reversed in parts after the US president paused tariffs on China, but investor focus in the bond market quickly shifted to America’s fiscal trajectory.
‘Loss of confidence’
European Central Bank president Christine Lagarde told La Tribune Dimanche in an interview published on Saturday that the US dollar’s recent decline against the euro is counterintuitive but reflects “the uncertainty and loss of confidence in US policies among certain segments of the financial markets”.
Rising Treasury yields would also complicate the government’s ability to cut back by running up its interest payments, while also threatening to weaken the economy by forcing up rates on loans such as mortgages and credit cards.
US Treasury Secretary Scott Bessent downplayed concerns over the US’s government debt and the inflationary impact of tariffs, saying the Trump administration is determined to lower federal spending and grow the economy.
Asked about the Moody’s Ratings downgrade of the country’s credit rating on Friday during an interview on NBC’s Meet the Press with Kristen Welker, Bessent said, “Moody’s is a lagging indicator – that’s what everyone thinks of credit agencies.”
In a move that may help temper some of the negative market sentiment, President Trump said over the weekend he will have a phone call with Russian President Vladimir Putin on Monday morning to discuss how to stop the war in Ukraine.
Moody’s move was anticipated by many given it came when the federal budget deficit is running near US$2 trillion a year, or more than 6 per cent of the gross domestic product. The US government is also on track to surpass record debt levels set after World War II, reaching 107 per cent of GDP by 2029, the Congressional Budget Office warned in January.
Moody’s said it expects “federal deficits to widen, reaching nearly 9 per cent of GDP by 2035, up from 6.4 per cent in 2024, driven mainly by increased interest payments on debt, rising entitlement spending, and relatively low revenue generation”.
Despite such sums, lawmakers will likely continue work on a massive tax-and-spending bill that’s expected to add trillions to the federal debt over the coming years. The Joint Committee on Taxation had pegged the total cost of the bill at US$3.8 trillion over the next decade, though other independent analysts have said it could cost much more if temporary provisions in the bill are extended.
Analysts at Barclays said in a report that they did not expect the Moody’s downgrade to change votes in Congress, trigger forced selling of Treasuries or have much impact on money markets. Treasuries have often rallied after similar actions in the past.
“Credit downgrades of the US government have lost political significance after S&P downgraded the US in 2011, and there were limited, if any, repercussions,” said Michael McLean, Anshul Pradhan and Samuel Earl of Barclays.
Around the same time Moody’s was announcing its decision, the US Treasury was reporting China had reduced its holdings of Treasuries in March.
While that may further encourage speculation the world’s second-largest economy is lowering its exposure to US debt and the US dollar, Brad Setser, a former Treasury official, said on X that the data suggested “a move to reduce duration than any real move out of the US dollar”.
Despite the recent trade tensions and worries over fiscal profligacy, the Treasury statistics suggested foreign demand for US government securities remained strong in March, indicating no signs of a revolt against American debt.
Still, traders will be hard at work early again on Monday, just a week since they had to react quickly to weekend news of an improvement in trade relations between the US and China. BLOOMBERG
