The US Downgraded: Bonds, Borrowing, & Budget Binds

To put this downgrade into perspective, the US went from the best to second best notch in a 21-notch system. In the statement released by Moody’s to justify the downgrade, they recognised that the US retains “exceptional credit strengths such as the size, resilience and dynamism of its economy”. Whilst it is never good for a sovereign (specially the largest global economy) to be downgraded, a AA1 rating is still very strong. In fact, Moody’s is the last of the three major credit rating agencies to downgrade the US from its top rating, with S&P Global having done so in 2011, and Fitch Ratings in 2023.

What has the market effect been? Both US bond and equity markets were negatively affected by this news at the beginning of the week. US government bond yields (which move inversely to prices) hit their highest level since 2023 on 30-year US Treasuries, while US equity markets ticked down.

Where do we go from here? This news has amplified the short-term sentiment that investors are becoming more wary of America’s fiscal trajectory. The US has long enjoyed the privilege of running large deficits without much consequence. Some investors are voicing concerns that inconsistent policymaking from Washington could erode confidence in what has traditionally been seen as a safe haven. For now, the downgrade serves as a warning shot: not an immediate crisis, but a signal that the world is watching how the US manages its mounting debts.

Long term investors would do well to remember that the US remains the world’s largest and most dynamic economy, with deep capital markets and global influence. That doesn’t disappear overnight with a credit downgrade.

The Noise

• Tariff talk was put on pause this week, with President Trump and his team working hard to get their “Big, Beautiful bill” passed by the house, which it did by the narrowest of margins. The more than 1,000-page bill includes extended tax cuts, added requirements for federal benefits eligibility, and an increase to the national debt ceiling. Treasury Secretary Scott Bessent argues that the bill will boost business sentiment and unlock spending and investment, however bond market participants see something else. The treasury on Wednesday found tepid demand at an auction of 20-year bonds, a sign that the investors are not enamoured by plans to continue growing the US fiscal deficit. US stocks also took a tumble this week, pulling off a three-day losing streak for the first time in over a month.

• After years of moving at a glacial pace, yields (which are inversely related to price) in Japan’s $7.8 trillion government debt market are shifting higher at breakneck speed. Evidencing this, both the 30-year and 40-year government bonds reached their highest levels since records began in 1999 this week. The Bank of Japan has been scaling back its bond purchases as the economy puts deflation behind it, but big local government bond buys such as the nation’s life insurers are yet to fill the demand gap left by the central bank. While price have fallen in an attempt to entice demand, many are sitting on the sideline, spooked by the volatility and risks triggered by US President Trump’s tariffs onslaught. Comments from Prime Minister Shigeru Ishiba did little to drum up demand, likening Japan’s financial position to that of Greece in the 2010s.
  
• UK inflation rose to 3.5% in April, higher than expectations, and marking the highest inflation level in the UK in 15 months. Economists have attributed this sharp rise to higher energy prices, water bills, and higher airfares. Traders slashed expectations of further interest rate cuts, favouring just one more quarter-point cut by the end of the year. Following the release of the figures, the pound strengthened as much as 0.6% against the dollar to $1.347, the strongest level since February 2022.

The Niche

Keeping our fun fact of the week on theme around debt and the bond market; In 1997, Disney issued a "Sleeping Beauty bond" that matures in the year 2093. But that’s nothing compared to Oxford University, which issued a 1,000-year bond in the 1990s which won’t mature until the year 2960.