The United States lost its 3A rating again. Is it really a deterrent to Washington?

After Moody's downgraded its rating on May 16, the US government lost its last 3A highest credit rating among major international rating agencies. This is a milestone event worthy of vigilance for the world's largest economy.

In explaining the reasons for the downgrade, Moody's analysts pointed out that over the past decade, successive US governments and Congresses have failed to effectively curb the huge fiscal deficit. According to data from the Government Accountability Office (GAO) under Congress, the US government's debt interest payments have surged as inflation soared after the COVID-19 pandemic, and are expected to reach $1 trillion in 2024, far exceeding the $263 billion in 2017.

To make matters worse, the US debt situation may deteriorate further. Republican lawmakers are discussing Trump's proposed tax cuts and fiscal spending draft, and critics say the plan will add trillions of dollars to the federal debt in the next decade.

Why did Moody's downgrade the US rating?

Currently, the US national debt is about $36 trillion. According to the Peterson Foundation, this is equivalent to about $106,100 in debt per American.

As early as 2011, S&P Global Ratings had downgraded the US credit rating. Fitch followed suit in 2023. With the end of the ultra-low interest rate era, the US government has to spend a larger portion of its revenue on debt interest payments. Moody's expects federal interest payments to account for about 30% of revenue by 2035, far exceeding 18% in 2024 and just 9% in 2021.

In fiscal 2024, the federal government spent $1.8 trillion more than it took in, the fifth consecutive year the fiscal deficit exceeded $1 trillion. The GAO warned that if policies are not adjusted, the size of the debt held by the public will be twice the GDP by 2047. The agency believes that this situation is unsustainable and decisive action must be taken.

In fact, Moody's warned of a possible downgrade as early as November 2023, when it downgraded the rating outlook from "stable" to "negative."

What does Aa1 mean?

Moody's currently rates the U.S. at "Aa1," its second-highest rating, equivalent to the "AA+" sovereign ratings given to the U.S. by S&P and Fitch.

Moody's describes "Aa1" debt as "still high quality, very low risk," second only to Aaa's "highest quality, lowest risk."

How did it come to this?

Simply put, federal tax revenues have not kept pace with government spending. Especially since the global financial crisis and the COVID-19 pandemic, the recession has prompted governments to introduce large-scale economic stimulus programs to maintain employment and investment.

Since the 1980s, the U.S. government has implemented multiple rounds of tax cuts aimed at stimulating the economy and improving taxpayers' financial conditions, but has failed to cut spending in parallel to make up for the deficit.

What are the implications?

In other countries, runaway fiscal deficits could cause investors to sell their currencies and local currency-denominated bonds, which would push up interest rates and force policymakers to eventually take a more responsible fiscal stance.

But the dollar is the world's reserve currency and the main settlement currency for global trade, so even if the U.S. fiscal deficit expands, the country's debt costs will not be ridiculously high.

On the first trading day after the Moody's downgrade, the yield on the 30-year U.S. Treasury bond rose above 5%, a psychologically important level. Long-term interest rates have only broken this level a few times in the past 20 years.

The unexpected downgrade of the U.S. sovereign rating has sent shockwaves through the economic and political landscape. How important is the U.S. credit rating?

Credit ratings are essentially independent assessments of the entities that issue bonds. Rating agencies assess the financial condition of borrowers and assign them a score, or rating, on their ability to repay the debt. Investors often rely on credit ratings to decide whether to buy new bonds issued by a particular issuer, so ratings play an important role in determining financing costs.

For the United States, credit ratings have a relatively limited impact on government borrowing costs because there is always strong demand for the U.S. dollar and U.S. Treasuries, which are seen as the benchmark for global fixed-income assets. The U.S. federal government has never defaulted on its debt and is generally considered unlikely to default in the future.

In an interview with NBC host Kristen Welker, U.S. Treasury Secretary Bessant said, "Moody's is a lagging indicator, and that's how everyone thinks about rating agencies."