What does it mean that Moody’s downgraded the United States credit rating?

Moody’s rating on Friday announced a downgrade to the US government’s credit rating, moving down a step further from the highest tier of rating agencies amid concerns over rising national debt, potentially affecting the larger market.

Credit ratings are used by analysts to determine the creditworthiness of debts issued by a government or a company. A higher credit rating at or near the top of the rating scale is considered to have a lower default risk than the risk at the bottom of the scale.

If a rating agency downgrades a country or a company’s credit rating, it could serve as a signal to the market that debt could potentially bring higher interest rates to compensate for risk. In the case of the federal government, it means increasing spending on interest costs arising from government bonds.

The company said the downgrade “reflects a decade-long increase in government debt and interest payment rates, reflecting a significantly higher level than the sovereigns that are similarly valued.”

“All US administrations and Congress have not agreed to measures to reverse the trend of large annual fiscal deficits and interest growth,” the company explained. “We don’t believe that the multi-year reduction in mandatory spending and deficit material will stem from current fiscal proposals.”

Moody’s downgrades US credit ratings for rising debt

Moody’s downgrade of US credit ratings from AAA to AA1 on the 21-notch scale was announced after the market closed on Friday, May 16th. During Monday’s trading session, Benchmark 10-year Treasury bond yield peaked at 4.56%, falling to around 4.45%. The 10-year yield began in years above 4.5%, up this month, from around 4.3% for most of March and April.

Ten years are used as benchmarks for other interest rates, such as mortgages and corporate bond yields.

Treasury Secretary Bescent dismisses Moody’s US credit downgrade as a “delay indicator”

Congress is considering a tax package that will widen the deficit in the coming years. (Saul Loeb/AFP via Getty Images)

In March, Moody’s warned that growth in national debt has become unsustainable, increasing the risk of downgrades the United States. “Even in very positive and low probability economic and financial scenarios, the affordability of debt remains substantially weaker than the highly rated sovereignty in other AAA ratings.”

The company said interest costs on debt are projected to rise from 9% of federal revenue to 30% of revenue by 2035. This helped support the AAA ratings of the US Treasury and the importance of the US dollar as a global reserve, but “these strengths have eliminated fiscal obstacles and reduced debt.”

Moody’s downgrade will reduce US credit ratings from the top tier, the third of the three major rating agencies.

Moody’s warnings that the US government’s financial strength is deteriorating

Treasury Secretary Scott Bescent has dismissed Moody’s downgrade as a “lagging indicator.” (Andrew Harnik/Getty Images)

In August 2023, Fitch ratings lowered the US from its highest rating of “AAA” to “AA+” and cited “Governance Erosion.”

Fitch said the federal deficit has expanded and exacerbated already massive national debt, and the looming financial challenges posed by increased spending on social security and Medicare have contributed to the move. He also said that when the US economy predicted a mild recession between late 2023 and early 2024, the US economy ultimately did not fall into a recession during that period.

The first US debt downgrade occurred in 2011 amid a congressional deadlock during discussions on spending cuts and debt restrictions as Standard and Poor’s (S&P) was reduced from “AAA” to “AA+” over financial concerns.

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The S&P showed that “long-term controversy about raising the statutory debt cap and related fiscal policy debate” is unlikely to reduce increases in federal spending or stabilize the federal government’s debt burden.