Moneycontrol Pro Panorama | Moody's US Downgrade: Will it really affect market sentiment?

Markets are also digesting news that the administration may invoke the Trade Act of 1974 to push through tariffs of up to 15% for 150 days, bypassing current legal barriers.

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The United States finds itself at a fiscal crossroads, grappling with mounting debt pressures that threaten to intensify under President Donald Trump's proposed tax cuts. This precarious financial position has now been formally acknowledged by Moody's Ratings, which stripped the American government of its coveted AAA credit rating, downgrading the nation to Aa1 over the weekend.

The market's immediate response was swift but measured. Global equity markets declined while US Treasury yields surged on Monday, with 10-year bonds climbing three basis points to approximately 4.50 percent and 30-year securities rising four basis points to 4.99 percent. This marked a significant milestone as yields approached the five percent threshold last seen in 2023 when they peaked at 5.18 percent—the highest level since 2007.

However, the reaction is expected to be short-lived. Treasury Secretary Scott Bessent captured the mood in a recent NBC interview, dismissing Moody's as "a lagging indicator", a sentiment shared among financial professionals regarding credit rating agencies.

Bessent's assessment carries particular weight when applied to Moody's track record. Moody's has been the most reluctant among the three major rating agencies to downgrade US sovereign debt. Standard & Poor's lowered America's rating as early as August 2011 while Fitch followed suit in August 2023. Moody's latest action represents less of a groundbreaking assessment and more of an overdue acknowledgement of fiscal realities already recognised by its competitors.

The fundamental challenge facing the United States is stark and undeniable. The nation currently runs an annual budget deficit approaching $2 trillion, representing more than 6 percent of gross domestic product. The Congressional Budget Office's January warning proved prophetic, projecting that government debt would surpass the record levels established after World War II, potentially reaching 107 percent of GDP by 2029.

Moody's analysis paints an even more sobering picture for the decade ahead. The agency projects federal deficits will expand dramatically, reaching nearly 9 percent of GDP by 2035, up from 6.4 percent in 2024. This deterioration is due to escalating interest payments on existing debt, rising entitlement spending obligations, and relatively modest revenue generation capacity.

The information contained in Moody's report is already discounted. For markets, the more pressing question is the ongoing US-China trade negotiations and tariff discussions.

Had Moody's downgrade occurred during the height of trade tensions when markets were more fragile, its impact would likely have been far more pronounced. With a current truce in place and diplomatic channels relatively stable, markets appear positioned to absorb this development and continue forward.

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