Investor concerns about an impending debt time bomb have been intensified by a Moody’s downgrading of the U.S. sovereign, which may incite bond market vigilantes who demand greater fiscal constraint from Washington. Citing worries over the nation’s mounting $36 trillion debt load, the ratings agency was the latest of the five ratings agencies to drop America’s spotless sovereign credit rating, lowering it by one notch on Friday.
The action was taken as Republicans, who now control both the Senate and the House of Representatives, attempt to pass a comprehensive package of spending increases, tax cuts, and safety-net cutbacks that may increase the amount of debt in the United States by trillions.
Is Trump’s big, beautiful bill worsening the deficit?
The uncertainty around the ultimate form of the so-called “Big Beautiful Bill” puts investors on edge despite the fact that trade has become more optimistic. Despite calls for unity around the measure from U.S. President Donald Trump, the package failed to overcome a crucial obstacle on Friday.
Carol Schleif, chief market strategist at BMO Private Wealth, stated that Moody’s rating would cause investors to become more cautious.
“The bond market has been keeping a sharp eye on what transpires in Washington this year in particular,”
she added.
“As Congress debates the ‘big, beautiful bill,’ the bond vigilantes will be keeping a sharp eye on making them toe a fiscally responsible line,” she added, alluding to bond investors who penalize bad policies by making borrowing by governments unaffordable.
How will downgrades affect U.S. borrowing costs?
According to Spencer Hakimian, founder of Tolou Capital Management in New York, the Moody’s downgrading, which comes after such actions by Fitch in 2023 and Standard & Poor’s in 2011, would “eventually lead to higher borrowing costs for the public and private sector in the United States.”
However, because most funds updated their parameters following the S&P downgrade, Gennadiy Goldberg, head of U.S. rates strategy at TD Assets, stated that the rating fall was unlikely to cause forced selling from funds that can only invest in top-rated assets.
“But we expect it to refocus the market’s attention on fiscal policy and the bill currently being negotiated in Congress,”
Goldberg stated.
Are investors losing confidence in Washington’s fiscal plans?
According to Scott Clemons, chief investment strategist at Brown Brothers Harriman,
“One question is how much pushback will be in Congress over whether fiscal principles are being sacrificed.”
He also added that a bill that demonstrates wasteful spending could act as a deterrent to increasing exposure to long-dated Treasuries.
According to the independent think tank Committee for a Responsible Federal Budget, if lawmakers prolong the bill’s temporary measures, the total national debt may increase by around $5.2 trillion or $3.3 trillion by 2034.
The pattern of rising fiscal deficits and interest rates has not been reversed by succeeding administrations, according to Moody’s, which stated on Friday that it does not anticipate significant deficit reductions from the fiscal ideas being considered.
The market price reflects this concern. According to Anthony Woodside, head of fixed income strategy at Legal & General Investment Management America, a recent rise in the 10-year Treasury term premium—a gauge of the return investors demand for the risk of holding long-dated debt—is partially an indication of underlying fiscal anxiety in the market. According to Woodside, the market was “not assigning much credibility” to the reduction of the deficit in a meaningful manner.
The Moody’s downgrade was described as political by the White House. In response to the action, White House communications director Steven Cheung called out Moody’s analyst Mark Zandi as a Trump political foe in a social media post on Friday. Zandi declined to comment. Zandi is chief economist at Moody’s Analytics, which is not affiliated with the ratings agency.
Because of tariff income and budget offsets, some market participants think the tax package will improve the fiscal picture relative to prior projections. In contrast to the $3.8 trillion that was anticipated prior to Trump’s election, Barclays now projects that the plan will raise deficits by $2 trillion over the next ten years.
