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Macro Perspectives: US ‘AAA’ no more … but does it matter?

Anthony Willis

Senior Economist

Key Takeaways

Moody’s has cut the US’s sovereign credit rating to Aa1 on concerns that the federal deficit will widen to 9.4% of GDP by 2035, up from 6.4% in 2024.
Although the downgrade will have little practical impact, it comes as President Trump’s ‘One Big Beautiful Bill Act’ could increase national debt by $3.3 trillion over the next decade.
Limited spending cuts within the bill do not offset the proposed tax cuts, with tariffs revenue unlikely to plug the gap. This means the US deficit will likely grow swiftly from its current $36.2 trillion.
With interest payments on the deficit close to $1 trillion this year, and fiscal restraint unlikely to come from the Republican party, could the bond market present the Trump administration with its own ‘Liz Truss moment’?
The US Federal Reserve is usually acutely aware of any stresses in the bond market and will likely act to ensure a bond crisis doesn’t become a financial crisis. But the bar for intervention is high – we will likely see some volatility beneath that.

Transcript

The past week has seen the new federal budget making the headlines, as Republicans try to agree on a deal that will pass through Congress without Democrat support. The debate has taken place against a backdrop of a warning shot fired by the Moody’s rating agency, who downgraded the US from a AAA rating to Aa1. This means that none of the major ratings agencies now give the US the highest credit rating. S&P downgraded the US as far back as 2011, citing deficit concerns. Very little has changed since then, with the US currently running a budget deficit of 6.8% – a level only usually seen in a recession.

Moody’s said it expected the federal deficit to widen to 9% of GDP by 2035, from 6.4% in 2024, owing to increased payments of debt, entitlement spending and ‘relatively low revenue generation’. Treasury Secretary, Scott Bessent, has previously promised to cut the deficit to 3% by the end of President Trump’s presidential term – a level that will either require a lot of growth or a lot of fiscal discipline.

The Moody’s downgrade has little practical impact, but it does dampen sentiment and is very timely given the focus on the US budget, its implications for future borrowing and the apparent lack of concern in Washington over the direction of the deficit.

Trump has attempted to package many of his election promises on tax into what is now officially called ‘The One Big Beautiful Bill Act’, which is now making its way through Congress. The non-partisan Committee for a Responsible Federal Budget estimates the bill will increase the US national debt by at least $3.3 trillion over the next decade.

The market reaction to the US downgrade saw some volatility in US Treasuries, most notably in longer duration debt. Markets are expecting a resolution to the budget, with a deal set to pass Congress in the not-too-distant future. However, it seems likely this bill will do little or nothing to address the debt issues. The limited spending cuts in the bill will fail to offset the proposed tax cuts, or the extension of tax cuts introduced in 2017. Revenues from tariffs are unlikely to plug the gap. Last year the US took $100 billion in tariffs compared to overall receipts of $4.9 trillion. This year, the expected tariffs number may well be in the $150-$300 billion range – but the upper bound of that range would infer that reciprocal tariffs are reimposed, which appears unlikely. This leaves the US with a deficit likely to grow swiftly from the current$ 36.2 trillion, with interest payments on it likely to be close to $1 trillion this year, up three-fold since 2020.

With the US deficit growing at a pace of around $1 trillion every 100 days, what will bring a halt to this ever-growing debt burden? It seems unlikely that fiscal restraint will come from the Republican party or the current administration, so will the bond market finally scream ‘enough’ and give Trump a ‘Liz Truss moment’?

US Treasuries still have the luxury of being seen as the ultimate risk-free asset (if you assume the US government won’t default), while the US dollar remains the world’s reserve currency. This should mean that there is always a substantial level of demand for US debt. But it seems likely investors will want higher rewards for owning that debt.

US government bonds will be priced against a backdrop of the risk of higher inflation and a slowing economy thanks to tariffs, with the US Federal Reserve (Fed) in ‘wait and see mode’, more concerned over the inflation side of their mandate rather than employment. We have seen in the past that the Fed is acutely aware of any stresses in bond markets, and will intervene if necessary to ensure that a bond crisis does not become a financial crisis. But the bar for intervention is high, and beneath that we may well see some volatility.

Yields rising slowly over time are much easier to digest than a sudden spike, but the news backdrop around the deficit lends itself to swift changes in market mood and the kind of spikes in yields that cause fallout across risk assets. There are definitely reasons to feel a little more nervous about the trajectory of US debt and how this will influence risk appetite across all financial markets.

28 May 2025

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Macro Perspectives: US ‘AAA’ no more … but does it matter?

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Macro Perspectives: US ‘AAA’ no more … but does it matter?

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