Downgrading U.S. Government Debt Rating and What That Means
On May 16th, Moody’s, the last of the three major credit rating agencies, downgraded U.S. debt from the highest rating of AAA to AA, following similar decisions by Fitch in 2023 and S&P in 2011. Moody’s cited similar concerns as the other two agencies, primarily growing debt fueled by increased federal spending, increased tax cuts, and rising interest rates. Other concerns include domestic political divisions, eroding governance, geopolitical tensions, and macroeconomic headwinds. However, the specific trigger for the timing of the downgrade came in the form of that Big Beautiful Bill passing the House and Moody’s assessment that it is not so beautiful after all. With this downgrade, we have officially left the small and exclusive club of countries with perfect AAA credit ratings, like Australia, Germany, and Canada. Instead, according to these agencies, U.S. government debt is more accurately compared to the likes of Taiwan, Qatar, and France.
So, you may ask yourself, does it matter and who cares? Depending on what lens you look through, you may arrive at different answers. If you look through a political lens, the answer to both questions is no, it doesn’t matter, and no one cares. The voting public and their representatives are sharply divided, and they surely will not come to any kind of consensus anytime soon. In fact, the credit agencies site the inability of successive U.S. administrations (and Congress) controlled by either party to effectively address the trends of fiscal deficits and interest costs. Seeing as how downgrades were issued over the span of the past 14 years, the voting public is at risk of acting like the frog in a pot of water that is slowly being cooked alive. The metaphor represents a complacent public comfortable enough with the status quo, not realizing that small incremental changes may result in a large existential threat down the road. By the time the public decides to break away from the status quo, it is too late to reverse, or even change, the trajectory. Yet perhaps a combination of higher costs, inflation, and interest rates may be just enough to wake the frog and jolt the public into decisive action. But I wouldn’t hold my breath.
Alternatively, if viewed through a finance lens, one may come to a different conclusion . In this case, a group of stakeholders, namely the bond investor and specifically the buyer of Treasury bonds, emerges with the power to shock the system into action . Our metaphor changes from a frog in a pot to a three-legged stool. This stool has been strong for a long time, supported by three interconnected rating agencies that ultimately provide debt its structural soundness. After all, Moody’s has maintained its AAA rating on U.S. government debt for over a century since 1917. However, with each agency downgrade, the bond investor has taken notice and has sounded its alarm, albeit temporarily. With Moody’s decision in May, each leg has now been issued a sharp blow. While the legs continue to be strong, at some point, additional hits will splinter them until one reaches the point of buckling under the weight of bond investor speculation. Just imagine if the once all-powerful risk-free treasury bond is grouped along with Chinese and Saudi Arabian debt in the future. The hope, of course, is that the bond investor alerts the stool owner, the American people, before a leg buckles and demands decisive action from its representatives to change course. That I would take to the bank.
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