[SINGAPORE] Local bank OCBC remains positive about the investment outlook for the next one year, despite Moody’s downgrade of the United States’ credit rating on Friday (May 16).
The ratings agency downgraded the US from “AAA” – the highest rating for credit reliability – to “AA1”, citing rising fiscal deficits and higher interest payments.
Nevertheless, Vasu Menon, managing director for investment strategy at OCBC, said on Sunday that while the downgrade could initially weigh on US stocks, US government debt still enjoys the second-highest rating.
“It does, however, reinforce concerns about the growing US budget deficit and debt. But these are not new and have been discussed extensively over the past few months, and even years,” he added.
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Growing US debt
Moody’s said in a statement on Friday that while Treasury assets remain in high demand, higher yields since 2021 have increased the interest burden on US debt.
The agency projected that federal deficits would widen from 6.4 per cent in 2024 to nearly 9 per cent of the US’ gross domestic product by 2035, driven by increased interest payments, rising entitlement spending, and relatively low revenue generation.
It also expects the US federal debt burden to rise to about 134 per cent of GDP by 2035, up from 98 per cent in 2024.
No lasting impact in past downgrades
Menon noted that historical trends show past downgrades by S&P and Fitch did not have a lasting impact on markets unless US Treasury yields rose sharply.
S&P’s downgrade in 2011 was the first time the US lost its “AAA” rating. While US stock indices and global equities declined sharply on the first trading day after the downgrade, equity markets returned to positive territory within three to six months.
Similarly, stock markets did not see a significant drop immediately following Fitch’s downgrade in 2023. However, a sharp increase in US Treasury yields three months later – triggered by concerns over US inflation – did cause both US and global equities to pull back. As inflation fears eased and Treasury yields fell, equities rebounded and ended in positive territory six months after the downgrade.
Menon added that Moody’s latest move “should not come as a total surprise” as the agency had already lowered its outlook on the US from “stable” to “negative” in November 2023.
“The downgrade will, however, add to growing concerns about the loss of US exceptionalism and make non-US assets more appealing to global stock investors who have been rotating out of US equities into other markets like European equities,” said Menon.
Markets will also be watching developments around the Trump administration’s tariffs, as well as the US Federal Reserve’s interest rate policy – both of which could impact Treasury yields.
The US 10-year Treasury yield has hovered between 4 per cent and 4.5 per cent over the past three months.
However, if fears of a recession or a significant slowdown in the US economy resurface, this could limit further increases in Treasury yields, Menon said.
The market is also expected to remain volatile amid uncertainty over US trade, fiscal and monetary policies, he added.
Diversified portfolio, short-term maturities preferred
“Investors should continue to stay invested through a diversified portfolio and manage risk through a dollar-cost averaging strategy. We remain optimistic on equities, and currently prefer Europe and Asia ex-Japan (China, Hong Kong, Singapore),” said Menon.
For fixed-income bonds, OCBC favours high-quality, investment-grade options, focusing on short-term maturities of one to three years and medium-term maturities of three to seven years. These are less susceptible to rate volatility and offer investors greater stability, he noted.
OCBC is also positive on gold, with a 12-month target of US$3,900 for the precious metal, he added.
