Last week, Moody’s downgraded its US credit rating due to concerns about a $36 trillion debt pile. The move could complicate President Donald Trump’s efforts to cut taxes through financial markets.
Moody’s rating agency removed one US government credit score from the pristine AAA to AA1. It cited debt, interest rise and interest costs “are much higher than the sovereigns that are valued similarly.”
Last week’s cuts followed a downgrade by rating rival Fitch, which reduced the US credit score by one notch in 2023. Fitch was the second major rating agency to strip the US from its AAA ratings after Standard & Poor’s did that in 2011.
Investors use credit ratings to assess risk profiles for businesses and governments. The lower the borrower’s rating, the higher the cost of funding.
What reasons did Moody give for the downgrade?
“All US administrations and Congress have not agreed to measures to reverse the trend of large annual fiscal deficits and interest costs,” Moody’s said in a news release last week.
“For over a decade, US federal debt has risen sharply due to the ongoing fiscal deficit. During that time, tax cuts have led to an increase in federal spending while government revenues have been reduced,” he said.
The downgrade was the first time since 1949 that Washington’s credit score had been reduced since the year Moody’s began to assess US government debt.
Since returning to the White House in January, Trump has said he will balance his budget, with Treasury Secretary Scott Bescent repeatedly saying the administration is aiming to cut borrowing costs.
But Trump’s attempts to cut spending through Elon Musk’s government efficiency are far below his initial target. As things stand, Washington’s debt is increasing by about $1 trillion every three months.
Meanwhile, it is not yet clear whether attempts to raise revenue through tariffs that have sparked concerns about the trade war and global slowdown will work. Most economists think they are not.
For decades, US government bonds have served as a global “risk-free” benchmark for other financial assets. But that is increasingly being called into question.
How serious is the US debt problem?
A whopping 16% (or $684 billion) of tax revenue was used this year to cover debt interest payments, according to US Treasury data. In comparison, in Germany, that figure is close to 4%.
Moody’s said it expects the US federal deficit to grow to 9% of GDP by 2035, with a relatively low (tax) forecast from 6.4% in 2024, “mainly driven by increased interest on debt.”
Compared to 98% in 2024, we expected federal debt burden to rise to 134% of GDP by 2035.
Still, Moody’s argued that the US “holds extraordinary credit strengths in size, resilience, dynamism and the ongoing role of the US dollar as the global reserve currency.”
How did the Trump administration respond?
In a statement, White House spokesman Kush Desai said, “If Moody had been credible, they would not have been silent as the fiscal disasters (under President Joe Biden’s leadership) unfolded over the past four years.”
The White House characterized Moody downgrade as politically motivated. White House Communications Director Stephen Chan said Moody’s chief economist Mark Zandy is a Trump critic.
What is the background?
Trump is pushing lawmakers in his Republican-controlled Congress to pass a bill that extended the tax cuts introduced in 2017. The reductions, which were his first performance in signatures, significantly reduced corporate and personal taxes.
Moody’s recent downgrade came as bills extending these tax cuts failed to clear the procedural hurdles on Friday.
Later on Sunday, the holdout dropped the opposition and allowed it to pass the committee. Tax proposals are one step closer to voting by all rooms.
Moody’s said the fiscal proposals under consideration are inconsistent with the deficit and sustained reductions in ongoing tax reduction consultations.
“Moody’s downgrade of US credit rating should be a wake-up call for Trump and Congressional Republicans to end the reckless pursuit of tax gifts that destroy the deficit,” Senate Democratic leader Chuck Schumer said Friday.
“Sadly, I’m not holding my breath.”
What was the impact of the downgrade?
Moody’s downgrade has sparked fear of widespread investors revaluing US sovereign debt. As the demand for assets drops, so does prices. The yield (investments return from lending to the government) moves in the opposite direction.
On Monday, benchmark 10-year yields increased by more than 4.5%, affecting mortgage rates and borrowing costs for businesses and consumers. They’ve come down a little since then. The long-dated 30-year bonds also saw a yield jump.
Moody’s announcement sent uneasiness through the US stock market on Monday, but has recovered largely over the past two days. Meanwhile, Gold increased almost 1% to $3,220 to an ounce, but it went down on Tuesday and Wednesday.
Elsewhere, the value of the US dollar has fallen against a basket of currencies. The British pound, for example, rose to its highest level against the greenback from the beginning of May, rising to $1.35.
Why is it important?
Typically, a decline in credit ratings leads to an increase in bond yields. This will raise interest rates on all interest rates, from mortgages to car loans and credit card liabilities, as commercial banks use government bond yields as the basis for setting their own interest rates.
This is extremely important to Americans, one of the most beneficial people in the world. According to the International Monetary Fund, in 2023, the US household debt to GDP was recorded at 73%. Switzerland, Australia and Canada have household debt to GDP ratios of over 100%.
If the US government continues to spend more on increasing debt repayments, public spending on social security, healthcare, defense and more will be less because governments will be more expensive to maintain themselves.
Washington can raise taxes to generate more income to pay off debt. But Trump appears to be heading in the opposite direction — lowering both taxes and public spending.
Sovereign credit warnings, including last week, fall into investors’ trust. Losing AAA status from all three major rating agencies is a symbolic blow to American fame.