Moody’s cut the US rating one notch to Aa1 from Aaa.
This is 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 exhibiting 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.
Also read: Lingering Tariff Concerns Overshadow A Win On Inflation
Moody’s rating action is likely to reinforce the ongoing market theme around the US risk premium.
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. 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. In the near term, it is possible that this new headline further erodes global investors’ appetite towards US assets, albeit marginally. 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.
The rates and currency markets are potentially exposed to this new headline shock.
In sharp contrast to the market response to S&P’s surprising rating action in 2011, we do not anticipate that 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. On the currency side, the USD has already been under considerable downward pressure, and we anticipate that the downside risks will continue to predominate in the period ahead. Finally, should UST yields happen to settle at a higher level, this may ultimately represent a risk for the equity market valuation, but we believe that we are still far away from the potential pain threshold.
