Introduction
This May, the most dramatic “series” in the global capital markets got a fresh update—Moody’s suddenly hit the “downgrade button” on U.S. Treasury credit ratings, lowering its rating from Aaa to Aa1. This seemingly minor change forms a death cross with the USD 1.2 trillion in debt maturing in June. How will this financial storm, which has global implications, unfold? How should we interpret this capital drama?
Reasons for Moody’s Downgrade
Moody’s downgrade of U.S. sovereign credit is primarily based on the following reasons:
- Continued rise in fiscal deficit and debt size: Moody’s pointed out that over the next ten years, the U.S. fiscal deficit is expected to widen further, and government debt and interest burdens will continue to grow. Specifically, the U.S. federal fiscal deficit as a percentage of GDP is projected to increase from 6.4% in 2024 to nearly 9% by 2035, while the debt-to-GDP ratio is expected to rise from 98% in 2024 to 134% by 2035. As of now, the total federal government debt has already exceeded USD 36 trillion.
- Unsustainability of fiscal policy: Moody’s believes that the current U.S. spending plans are insufficient to significantly reduce future mandatory expenditures and deficits. Over the next decade, mandatory spending (including interest, Social Security, Medicare, etc.) will occupy a larger share of total U.S. government expenditure—projected to rise from 73% in 2024 to 78% in 2035. This means more budget resources will be directed toward debt repayment rather than public investment or services, further limiting fiscal flexibility.
- Political gamesmanship and policy stalemate: Several past U.S. administrations and Congresses have failed to reach agreements on deficit reduction. The current fiscal plans also fall short of achieving substantial cuts in mandatory spending and deficits. Furthermore, the outlook for the 2025 U.S. budget reconciliation bill is highly uncertain. The House version of the bill is projected to increase the fiscal deficit by USD 3.3 trillion over the next decade.
The Debt Ceiling Remains Unresolved
The U.S. debt ceiling has long been a “Sword of Damocles” hanging over the Treasury market. Although the ceiling has not yet been breached, partisan struggles over fiscal policy have increased market uncertainty around its adjustment. If the debt ceiling issue is not properly resolved, the U.S. government may face the risk of a technical default.
Global investors are changing their allocations to U.S. dollar assets. As central banks increasingly diversify their foreign exchange reserves, the premium on U.S. dollar assets is undergoing a structural decline. This means that the appeal of U.S. Treasury bonds is also diminishing. Investors may reduce their holdings of Treasuries, thereby pushing up Treasury yields and increasing U.S. financing costs.
Ray Dalio, founder of Bridgewater Associates, noted that Moody’s downgrade underestimates the risk of U.S. Treasuries because it does not account for the possibility that the U.S. might resort to printing money to repay its debts. While this approach may avoid a direct default, it would lead to currency depreciation, causing bondholders to suffer losses due to the reduced purchasing power of their returns.
Following Moody’s downgrade, the U.S. Treasury market responded swiftly. On May 19, the 30-year Treasury yield broke through 5%, and the 10-year yield also rose above 4.5%. The rise in yields reflects a market repricing of Treasury risk and adds to the government’s financing burden, further exacerbating fiscal pressure.
The rise in Treasury yields and the rating downgrade may also amplify market concerns about the U.S. dollar. After the announcement, the U.S. Dollar Index fell by about 2%, signaling shaken market confidence in the greenback. While the U.S. dollar’s status as the world’s primary reserve currency is unlikely to change in the short term, over the long run, the growing risks around Treasuries could undermine its appeal and accelerate the diversification of the global monetary system.
In the long term, the issue of U.S. fiscal sustainability will not be resolved quickly, and risks of an imbalance between Treasury supply and demand are on the rise. This suggests that the term premium on Treasuries may remain elevated—or even increase further.
Moody’s downgrade of the U.S. sovereign credit rating is not just a warning about America’s fiscal condition—it also serves as a wake-up call to global investors. Risks in the U.S. Treasury market can no longer be ignored. Investors must reassess their portfolios and cautiously navigate upcoming market changes. The U.S. government must face its fiscal deficit and debt issues head-on and implement effective corrective measures. Otherwise, turbulence in the Treasury market may intensify—and could even trigger a ripple effect throughout the global financial system.
[Disclaimer]: The above content reflects analysis of publicly available information, expert insights, and BCC research. It does not constitute investment advice. BCC is not responsible for any losses resulting from reliance on the views expressed herein. Investors should exercise caution.