By a bold whisker
NEW YORK (Reuters) – Moody’s downgrade to the US sovereignty has exacerbated investors’ concerns about the looming debt bomb that could spur bond market vigilantes who want to see financial restraints from Washington.
The rating agency reduced America’s untouched sovereign credit rating by one notch on Friday. This is the last of the major rating agencies that will downgrade the country.
The move could add trillions of dollars to the US debt pile as Republicans and Senate control of the House are seeking to approve a drastic package of tax cuts, spending hikes and cuts in safety nets. The uncertainty about the ultimate form of the so-called “Big Beautiful Building” has given investors the advantage despite the emergence of optimism over trade. The bill failed to clear important hurdles on Friday despite US President Donald Trump calling for unity around the legislation.
“The bond market is closely monitoring what’s going on, especially in Washington,” says Carol Schlife, chief market strategist at BMO Private Wealth.
“As Congress discusses the ‘big and beautiful bills, bond vigilantes have a keen eye for them toeing their financially responsible lines,” she said.
Spencer Hakimian, founder of Tolou Capital Management in New York, said a similar move from Fitch in 2023 and a downgrade from Moody’s that “eventually, the cost of borrowing for the public and private sectors will be higher” was
Still, rating cuts are unlikely to cause forced sales from funds that can only be invested in top securities, said Gennadiy Goldberg, US chief of TD Securities. “But we are expected to focus market attention on fiscal policy and bills currently negotiated in Congress,” Goldberg said.
Focus on buildings
Scott Clemons, the chief investment strategist of the Brown brothers Harriman, said one of the questions about how much pushback there will be in Congress about whether fiscal principles are at the expense of fiscal years, adds that bills showing abundant spending could be hampered from adding long-term exposure to the Treasury.
The Responsible Federal Budget Committee, a nonpartisan think tank, estimates that if policymakers extend the temporary provisions, the bill could add to around $3.3 trillion, or about $5.2 trillion in debt by 2034.
Moody’s said on Friday that the ongoing administration failed to reverse trends in higher fiscal deficits and interest costs, and did not believe it would arise from a fiscal proposal that considers reductions in deficit material.
Concerns manifest in market pricing. Legal and General Investment Management Anthony Woodside, head of US bond strategy, said the recent increase in the 10-year Treasury Term Premium – part of the measure of the demand for risk of holding long-term debt is part of the financial concerns in the market. Woodside said the market “doesn’t assign much credibility” because the deficit is materially overthrown.
Treasury Secretary Scott Bescent said the administration is focusing on containing the benchmark 10-year yield. The last yield seen at 4.44% was below about 17 basis points before Trump took office in January.
Garrett Melson, portfolio strategist at Natixis Investment Managers Solutions, said:
A White House spokesman dismissed concerns about the bill. “The experts are wrong. They were about the impact of Trump’s tariffs that recorded investment, employment growth and not inflation,” said Harrison Fields, the president’s special aide, in a statement.
The White House characterized Moody downgrade as political. White House Communications Director Stephen Chan responded to the move via a social media post on Friday, singled out Moody economist Mark Zandy and called him a political opponent to Trump. Zandy, the chief economist at Moody’s Analysis, is a separate entity from the rating agency and declined to comment.
Some people in the market believe that offsets in tariff revenue and expenditures will improve the fiscal outlook in the tax package compared to previous expectations. The Barclays estimates the cost of the bill that would increase the deficit by $2 trillion over the next decade compared to its forecast of around $3.8 trillion before Trump took office.
x factor?
As key deadlines approach, the urgency is increasing. House Speaker Mike Johnson said he would like to pass the bill in his room before his May 26th US Day holiday, but Bescent urged lawmakers to raise federal debt restrictions by mid-July.
The US government reached its statutory borrowing limit in January and began adopting “extraordinary measures” to prevent violating the limit. Bessent shows that by August the government can hit the so-called X-Date.
Investor tensions have begun to emerge over debt restrictions. The average Treasury bill yields scheduled for August are higher than those of the invoices of adjacent maturities.
There is a wide agreement within the Republican Party to extend Trump’s 2017 tax cuts, but there are differences in how they can achieve spending cuts that will help offset losses in revenue.
The operating rooms for spending reductions are limited. Commuter spending, including social welfare programs Trump has promised not to touch, accounts for a large portion of the total budget spending last year.
A politically viable fiscal package is likely to lead to a wider deficit in the near future, while at the same time not providing a meaningful financial boost to the economy, said Morgan Stanley’s Michael Zesas in a memo released last week.
Ann Walsh, chief investment officer at Guggenheim Partners Investment Management, said that if the actual process in Washington does not aim to significantly reset spending levels, there is unlikely to be any meaningful improvement in the US fiscal path.
“This is an unsustainable course we have,” she said.
(Reporting by Davide Barbuscia, Additional reporting by Carolina Mandl, Editing by Megan Davies and Anna Driver)
