Last week, Moody’s downgraded the credit rating of the United States due to concerns over its $36 trillion debt pile. The move sent ripples through financial markets and could complicate President Donald Trump’s efforts to cut taxes.
The Moody’s rating agency dropped the US government’s credit score by one notch from the pristine Aaa to Aa1. It cited rising debt and interest costs “that are significantly higher than similarly rated sovereigns.”
Last week’s cut followed a downgrade by rating rival Fitch, which lowered the US credit score by one notch in 2023. Fitch was the second major rating agency to strip the US of its AAA rating after Standard & Poor’s did so in 2011.
Investors use credit ratings to assess the risk profile of companies and governments. The lower a borrower’s rating, the higher its financing costs.
What reasons did Moody’s give for the downgrade?
“Successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs,” Moody’s said in a news release last week.
“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,” it said.
The downgrade marked the first time Moody’s has lowered Washington’s credit score since 1949, the year it began rating US government debt.
Since his return to the White House in January, Trump has said he would balance the budget while Treasury Secretary Scott Bessent has repeatedly said the administration is aiming to lower its borrowing costs.
But Trump’s attempts to cut spending through Elon Musk’s Department of Government Efficiency have fallen far short of its initial goals. As things stand, Washington’s debt is growing by about $1 trillion every three months.
Meanwhile, it is not yet clear if attempts to raise revenues through tariffs – which sparked concerns about a trade war and global slowdown – will work. Most economists think they won’t.
For decades, US government bonds have served as the global “risk-free” benchmark for other financial assets. Increasingly, however, that is being called into question.
How serious is the US debt problem?
According to US Department of the Treasury data, a whopping 16 percent (or $684bn) of tax revenues were used to cover debt interest payments this year. In Germany, by comparison, that figure is closer to 4 percent.
Looking ahead, Moody’s said it expected the US federal deficit to widen to 9 percent of gross domestic product (GDP) by 2035, up from 6.4 percent in 2024, “driven mainly by increased interest payments on debt… and relatively low [taxes]”.
It anticipated that the federal debt burden will rise to 134 percent of GDP by 2035, compared with 98 percent in 2024. For context, the debt-to-GDP ratio reached a record of 133 percent in 2020 during the COVID-19 pandemic.
Still, Moody’s maintained that the US “retains exceptional credit strengths such as size, resilience and dynamism and the continued role of the US dollar as the global reserve currency”.
How has the Trump administration responded?
In a statement, White House spokesman Kush Desai said: “If Moody’s had any credibility, they would not have stayed silent as the fiscal disaster of the past four years [under President Joe Biden’s leadership] unfolded.”
The White House characterised Moody’s downgrade as politically motivated. White House communications director Steven Cheung said Moody’s chief economist, Mark Zandi, was a critic of Trump’s.
What’s the backdrop?
Trump is pushing lawmakers in Congress, which is controlled by his Republican Party, to pass a bill extending tax cuts introduced in 2017. Those cuts, which were his signature first-term achievement, slashed corporate and individual taxes.
Moody’s recent downgrade came as a bill to prolong those tax cuts failed to clear a procedural hurdle on Friday as some Republicans in the House of Representatives demanded deeper spending cuts and then blocked the measure.
Then, late on Sunday, the holdouts dropped their opposition and allowed it to pass through committee. The tax proposal is now one step closer to a vote by the full chamber.
Moody’s said the fiscal proposals under consideration were inconsistent with a sustained reduction in the deficit and ongoing tax reduction talks would raise the debt burden to 134 percent of GDP over the next decade.
“Moody’s downgrade of the United States’s credit rating should be a wake-up call to Trump and congressional Republicans to end their reckless pursuit of their deficit-busting tax giveaway,” Senate Democratic leader Chuck Schumer said on Friday.
“Sadly, I am not holding my breath.”
What were the effects of the downgrade?
Moody’s downgrade stoked fears of a broad investor reappraisal of US sovereign debt. As demand for assets falls, so does their price. Yields (investor returns from lending money to the government) then move in the opposite direction.
On Monday, benchmark 10-year yields – which influence mortgage rates and borrowing costs for companies and consumers – rose to more than 4.5 percent. They have come down a little since then. Longer dated 30-year bonds also saw a jump in yields.
While Moody’s announcement sent jitters through US stock markets on Monday, they have largely recovered over the past two days. Gold, meanwhile, rallied almost 1 percent to $3,220 an ounce but then trended down on Tuesday and Wednesday.
Elsewhere, the value of the US dollar fell back against a basket of currencies. The British pound, for instance, rose to its highest level against the greenback since the start of May – to $1.35.
Why does it matter?
Lower credit ratings typically lead to higher bond yields, which will raise interest rates on everything from mortgages to car loans to credit card debt because commercial banks use government bond yields as a basis for setting their own interest rates.
This is crucial for Americans, who are among the most highly indebted people in the world. In 2023, US household debt relative to GDP clocked in at 73 percent, according to the International Monetary Fund. Switzerland, Australia and Canada have household debt-to-GDP ratios in excess of 100 percent.
If the US government continues to spend more on rising debt repayments, it will have less for public spending on things like Social Security, healthcare and defence as it becomes more costly for the government to sustain itself.
Washington could raise taxes to generate more revenue to pay down its debt. But Trump appears to be headed in the opposite direction – lowering both taxes and public spending.
Sovereign credit warnings, including last week’s, chip away at investor confidence. Losing AAA status from all three major rating agencies is a symbolic blow to American prestige.
