INSIGHTS

On May 21, 2025

U.S. Rating Downgrade

The news reflects ongoing uncertainty in several areas of U.S. policy, including around the shape of the U.S. budget, which is starting to worry markets.

Moody's cut its credit rating for the U.S. on Friday from Aaa to Aa1 (stable outlook) citing the federal government’s budget deficit and debt as key concerns. Moody’s had already placed the U.S. rating on negative outlook, so the news was not unexpected.

Moody’s is the last of the three major ratings agencies to cut the U.S. rating from the best possible rating. S&P downgraded the U.S. from AAA to AA+ in August 2011, and Fitch did so in August 2023.

U.S. 10-year Treasury yields rose 5 basis points (bps) on Friday overall, closing at 4.48%, a level similar to that reached around a week after “Liberation Day” on April 2, 2025.

We do not expect any forced selling of U.S. Treasuries as a result. However, the ratings downgrade reflects ongoing uncertainty regarding U.S. policy.

There has been a steady decline in ratings for U.S. Treasuries since the early 1990s (see Tables 1 and 2). The U.S. debt-to-GDP ratio and budget deficit have been on a worsening trend, which had led agencies to downgrade the rating over time. Credit downgrades of the U.S. government have lost political significance after S&P downgraded the U.S. in 2011, and there were limited, if any, repercussions. Ultimately, we do not expect there to be forced selling of U.S. Treasuries.

Table 1: S&P local-currency long-term debt rating for the U.S.

 Source: Insight Investment as of May 19, 2025

Table 2: Moody's local-currency long-term debt rating for the U.S.

Source: Insight Investment as of May 19, 2025

The news reflects ongoing uncertainty in several areas of U.S. policy, including around the shape of the U.S. budget, which is starting to worry markets. Early in his presidency, President Trump discussed government spending cuts, deregulation to accelerate growth, and revenue raised from tariffs, which he said would balance the cost of extending the 2018 tax cuts and any other expansionary policies. It appears this will not be the case. Republicans’ “One, Big, Beautiful Bill,” which includes significant tax cuts, has passed the House Budget Committee after initially failing to do so; the next step is the Rules Committee, before going to the full House for a vote.

Other news items impacting U.S. markets include speculation that there will be a change in U.S. banking regulations, loosening the Supplementary Leverage Ratio (SLR), which would make it less punitive for U.S. banks to own U.S. Treasuries. This could be helpful, leading to more entities who can buy more Treasuries and help absorb the high levels of issuance. The SLR constrains balance-sheet capacity and reduces banks’ ability to lend. You can see evidence that banks have been reined in, potentially too much, by looking at the growth of the private credit markets. These changes are likely to only impact the largest globally systematically important banks.

Insight's View: U.S. Treasuries

• We expect a U.S. economic slowdown to lead the Federal Reserve (Fed) to cut rates, but we believe uncertainty over tariffs and their potentially inflationary effects will stay the Fed’s hand. However, we think the Fed will act rapidly once it decides to cut.
• Curve steepening is a consensus trade, but we expect this in the near term due to the market repricing the front end of the curve given a higher likelihood of Fed cuts, rather than higher expectations that growth will lead the longer end of the curve to rise.
• That said, given heightened inflation risks, limited fiscal discipline and potential eroding confidence in the U.S. fiscal situation, we expect the term premium to rise somewhat over the horizon.

CRN: 2025-0520-12603 R

The opinions and views of this commentary are that of Insight Investment and are not necessarily those of Advisors Asset Management. Any forecasts or opinions expressed herein are Insight Investment's own as of May 19, 2025, and subject to change without notice.