NEW YORK – In a move that has intensified investor worries about the United States’ fiscal health, Moody’s Ratings on Friday cut its credit rating on the U.S. government by one notch. The decision follows similar actions by Fitch in 2023 and Standard & Poor’s in 2011, making Moody’s the last of the major ratings agencies to downgrade the country’s pristine sovereign credit rating. The downgrade, from Aaa to Aa1, diminishes the U.S.’s status as the world’s highest-quality sovereign borrower.
The Primary Drivers: Debt and Deficits
The core reasons cited by Moody’s for the downgrade are the increase over more than a decade in government debt and interest payment ratios to levels that are significantly higher than similarly rated sovereigns. According to Moody’s, U.S. lawmakers have failed to stem annual deficits or reduce spending over the years, leading to a growing national debt. The agency highlighted its concern that successive U.S. administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs.
As of January 2025, U.S. government debt surpassed $36 trillion and shows no signs of slowing. Moody’s analysis casts doubt on whether current U.S. fiscal proposals under consideration will achieve material long-term reductions in mandatory spending and deficits. The agency explicitly stated, “We do not believe that material multi-year reductions in mandatory spending and deficits will result from the current fiscal proposals under consideration”.
Looking ahead, Moody’s expects larger deficits over the next decade, driven by rising entitlement spending while government revenue remains broadly flat. The agency projects mandatory spending, including interest payments, to rise to around 78% of total U.S. spending by 2035, up from about 73% this year. Furthermore, Moody’s sees federal deficits widening close to 9% of GDP by 2035, a significant increase from 6.4% in 2024. This trajectory is expected to push the federal debt burden to around 134% of GDP by 2035, compared to 98% last year. A key assumption in Moody’s “base case” projection is the extension of the 2017 Tax Cuts and Jobs Act, which the agency estimates could add approximately $4 trillion to the federal fiscal primary deficit over the next decade.
Investor Reaction and Market Implications
The Moody’s downgrade has exacerbated investor worries about a looming debt “time-bomb”. Investors are currently laser-focused on the details of the U.S. tax package being debated in Washington and its potential impact on the budget deficit. This debate is occurring with mounting urgency as the package includes the critical task of raising the federal government’s debt ceiling.
Bond investor nervousness is already showing up in the market. For example, there is a kink in the T-bill yield curve, and the average yield on Treasury bills due in August is higher than the yield of bills with adjacent maturities, indicating nervousness around the debt limit and the potential “X-date” – the point at which the government could run out of cash to meet its obligations, projected by Treasury Secretary Scott Bessent for August.
The concept of “bond market vigilantes” is relevant in this context. These are bond investors who use their power to punish what they perceive as bad fiscal policy by making it prohibitively expensive for governments to borrow. Carol Schleif, chief market strategist at BMO Private Wealth, suggests that the Moody’s downgrade may make investors more cautious, and the bond vigilantes will be “keeping a sharp eye on making them toe a fiscally responsible line” as Congress debates the “big, beautiful bill”.
Some experts predict that the downgrade will “eventually lead to higher borrowing costs for the public and private sector in the United States”. This is a direct consequence of investors demanding higher returns to compensate for the perceived increased risk of holding U.S. debt. As the debt climbs and some investors potentially lose faith in U.S. government securities, bond yields would spike, causing debt service payments to go up, further inflating the national debt. This creates a “vicious cycle” where the government must offer ever-greater yields to incentivize investors to purchase its debt.
However, not all market participants were convinced of the immediate impact. Gennadiy Goldberg, head of U.S. rates strategy at TD Securities, believes the ratings cut is unlikely to trigger forced selling from funds that are restricted to investing only in top-rated securities. He notes that most funds revised their guidelines after the S&P downgrade in 2011. Nevertheless, Goldberg expects the move to “refocus the market’s attention on fiscal policy and the bill currently being negotiated in Congress”.
Concern about the fiscal path is also showing up in other market indicators. A recent increase in the 10-year Treasury term premium – a measure of the return investors demand for the risk of holding long-dated debt – is seen as partly a sign of underlying fiscal worry. Anthony Woodside, head of fixed income strategy at Legal & General Investment Management America, commented that the market was “not assigning much credibility” to the deficit being brought down in a material way. Garrett Melson, portfolio strategist with Natixis Investment Managers Solutions, noted that one could certainly see a reaction in yields to a substantial increase in the deficit at a time when the U.S. is already running pretty significant deficits. Treasury Secretary Scott Bessent has stated that the administration is focused on containing benchmark 10-year yields.
Investor reactions to the downgrade itself were mixed. Gabor Gurbacs, CEO and founder of Pointsville, cited the rating agency’s previous credit assessments during times of financial stress as unreliable, arguing that the current outlook was too optimistic. He referenced Moody’s having given Aaa ratings to sub-prime mortgage-backed securities that contributed to the 2007-2008 financial crisis. In contrast, macroeconomic investor Jim Bianco characterized the announcement as a “nothing burger,” arguing it did not reflect a real change in the perception of U.S. government creditworthiness.
The “Big Beautiful Bill” and Political Realities
Central to the current fiscal debate is the “Big Beautiful Bill,” a sweeping package of tax cuts, spending hikes, and safety-net reductions being pursued by Republicans controlling the House and Senate. This bill has the potential to add trillions to the U.S. debt pile. Uncertainty over its final shape has investors on edge.
Nonpartisan think tanks like the Committee for a Responsible Federal Budget estimate the bill could add roughly $3.3 trillion to the country’s debt by 2034. This estimate rises to around $5.2 trillion if policymakers extend temporary provisions included in the bill. Scott Clemons, chief investment strategist at Brown Brothers Harriman, highlighted the question of how much pushback there will be in Congress over whether fiscal principles are being sacrificed, suggesting that a bill demonstrating profligate spending could be a disincentive for investors to add exposure to long-dated Treasuries.
Achieving significant spending cuts to offset potential revenue loss from tax cuts presents a significant political challenge. There is broad agreement within the Republican Party to extend former President Trump’s 2017 tax cuts, but a divide exists on how to achieve spending cuts. The room for maneuver on spending reductions is limited, particularly because mandatory spending, including on social welfare programs that President Trump has pledged not to touch, accounted for a vast majority of total budgetary spending last year.
Some market analysts view the likely outcome pessimistically from a fiscal standpoint. Michael Zezas, a strategist at Morgan Stanley, noted that a politically viable fiscal package will likely lead to wider deficits in the near term and will not provide a meaningful fiscal boost to the economy. Anne Walsh, chief investment officer at Guggenheim Partners Investment Management, expressed the view that without a real process in Washington aimed at significantly resetting spending levels, a meaningful improvement in the U.S. fiscal path is unlikely. She characterized the current course as “unsustainable”.
However, there are alternative perspectives within the market. Some believe the fiscal outlook will improve with the tax package compared to earlier expectations, potentially due to tariff revenues and spending offsets. Barclays, for example, now estimates the cost of the bill to increase deficits by $2 trillion over the next 10 years, which is lower than expectations of around $3.8 trillion before President Trump took office.
White House Response and Political Framing
The White House has dismissed concerns around the bill and characterized the Moody’s downgrade as political. A White House spokesperson argued that “The experts are wrong, just as they were about the impact of Trump’s tariffs, which have yielded trillions in investments, record job growth, and no inflation”.
Following the downgrade announcement, White House communications director Steven Cheung reacted via social media, singling out Mark Zandi, an economist with Moody’s Analytics (a separate entity from the ratings agency), and calling him a political opponent of President Trump. Zandi declined to comment.
White House spokesman Kush Desai issued a statement asserting that “The Trump administration and Republicans are focused on fixing Biden’s mess by slashing the waste, fraud, and abuse in government and passing The One, Big, Beautiful Bill to get our house back in order”. Desai also stated that if Moody’s had any credibility, they would not have stayed silent as the fiscal situation unfolded over the prior four years.
Interestingly, in noting its decision to assign a stable outlook on its rating (meaning it’s not expected to change in the near future), Moody’s seemed to implicitly contrast its concerns with the perceived stability of U.S. institutions. The agency noted the U.S.’s “long history of very effective monetary policy led by an independent Federal Reserve”. It also cited “institutional features” within the U.S. government structure, including the “constitutional separation of powers” among the three branches, which Moody’s believes contributes to policy effectiveness over time and is “relatively insensitive to events over a short period”. Moody’s stated, “While these institutional arrangements can be tested at times, we expect them to remain strong and resilient”. This positive assessment of institutional strength appears to counterbalance the concerns about fiscal policy gridlock and growing debt, contributing to the stable outlook despite the rating downgrade.
Conclusion
Moody’s downgrade of the U.S. credit rating serves as a significant, though perhaps anticipated by some, signal about the concerns surrounding the nation’s fiscal trajectory. Driven by projections of expanding debt and deficits, exacerbated by rising mandatory spending and questions about the impact of current fiscal proposals like the “Big Beautiful Bill,” the downgrade highlights the challenges facing policymakers in Washington. While the immediate market impact might be debated, the move undeniably refocuses attention on the urgency of fiscal policy debates, particularly as deadlines approach for the tax package and raising the debt ceiling. The reactions from investors and the White House underscore the politically charged nature of these fiscal challenges, set against a backdrop of growing national debt and differing views on how to best secure the country’s economic future.
