Nearly four months after Donald Trump assumed charge as the President of the US, Moody’s Ratings on Friday downgraded the US government’s rating by one notch, reflecting the increase over more than a decade in government debt and interest payment ratios to levels that are significantly higher than similarly rated sovereigns.
The global rating firm slashed the long-term issuer and senior unsecured ratings of the US to Aa1 from Aaa and changed the outlook to stable from negative.
Moody’s said successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs. “We do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration,” it said.
“Over the next decade, we expect larger deficits as entitlement spending rises while government revenue remains broadly flat. In turn, persistent, large fiscal deficits will drive the government’s debt and interest burden higher,” Moody’s said. The US’ fiscal performance is likely to deteriorate relative to its own past and compared to other highly-rated sovereigns.
“The US retains exceptional credit strengths such as the size, resilience and dynamism of its economy and the role of the US dollar as global reserve currency. In addition, while recent months have been characterised by a degree of policy uncertainty, we expect that the US will continue its long history of very effective monetary policy led by an independent Federal Reserve,” Moody’s said.
While the markets may not like any rating downgrade, Wall Street is unlikely to register any deep cuts. However, it’s not an ideal situation for global investors who were keen to invest in the country’s securities. Many global investors pump money on the basis of a country’s rating.
Fitch had downgraded the US rating to AA+ from AAA in 2023 and S&P lowered US rating back in 2011.
Why it cut the rating?
Over more than a decade, US federal debt has risen sharply due to continuous fiscal deficits. During that time, federal spending has increased while tax cuts have reduced government revenues. As deficits and debt have grown, and interest rates have risen, interest payments on government debt have increased markedly, Moody’s said.
“Without adjustments to taxation and spending, we expect flexibility to remain limited, with mandatory spending, including interest expense, projected to rise to around 78 per cent of total spending by 2035 from about 73 per cent in 2024,” it said. If the 2017 Tax Cuts and Jobs Act is extended, which is our base case, it will add around $4 trillion to the federal fiscal primary (excluding interest payments) deficit over the next decade, it said.
“As a result, we expect federal deficits to widen, reaching nearly 9 per cent of GDP by 2035, up from 6.4 per cent in 2024, driven mainly by increased interest payments on debt, rising entitlement spending, and relatively low revenue generation,” it said. The federal debt burden will rise to about 134 per cent of GDP by 2035, compared to 98 per cent in 2024, it said.
Despite high demand for US Treasury assets, higher Treasury yields since 2021 have contributed to a decline in debt affordability. Federal interest payments are likely to absorb around 30 per cent of revenue by 2035, up from about 18 per cent in 2024 and 9 per cent in 2021. The US general government interest burden, which takes into account federal, state and local debt, absorbed 12 per cent of revenue in 2024, compared to 1.6 per cent for Aaa-rated sovereigns.
While we recognise the US’ significant economic and financial strengths, we believe these no longer fully counterbalance the decline in fiscal metrics, it said.
Will its long-term growth be affected?
The US economy is unique among various sovereigns. It combines very large scale, high average incomes, strong growth potential and a track record of innovation that supports productivity and GDP growth. “While GDP growth is likely to slow in the short term as the economy adjusts to higher tariffs, we do not expect that the US’ long-term growth will be significantly affected,” Moody’s said.
In addition, the US dollar’s status as the world’s dominant reserve currency provides significant credit support to the sovereign. The credit benefits of the dollar are wide-ranging and provide the extraordinary funding capacity that helps the government finance large annual fiscal deficits and refinance its large debt burden at moderate and relatively predictable costs. Despite reserve diversification by central banks globally over the past twenty years, we expect the US dollar to remain the dominant global reserve currency for the foreseeable future, Moody’s said.
“Underpinning the rating is our assumption that the US’ institutions and governance will not materially weaken, even if they are tested at times. In particular, we assume that the long-standing checks and balances between the three branches of government and respect for the rule of law will remain broadly unchanged,” Moody’ said.
Moreover, the resilience of the US sovereign rating to shocks is supported by strong monetary and macroeconomic policy institutions. “Although policy has been less predictable in recent months, relative to what has typically been the case in the US and other highly-rated sovereigns, we expect that monetary and macroeconomic policy effectiveness will remain very strong, preserving macroeconomic and financial stability through business cycles,” it said.
