On Friday, Moody’s became the last of the three major credit rating agencies to lower the United States’ credit rating to below triple-A (Aaa), downgrading it to Aa1. In August of 2023, Fitch reduced the U.S. credit rating to AA+ and way back in August of 2011, Standard and Poor’s reduced its rating to AA+. All three rating agencies have a stable credit outlook.
In the downgrade, Moody’s stated, “This one-notch downgrade on our 21-notch rating scale reflects the increase over more than a decade in government debt and interest payment ratios to levels that are significantly higher than similarly rated sovereigns.” Moody’s continued that, “Successive U.S. administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs.”
Since 1929, the deficit as a percentage of GDP has averaged -3.33%. Over the past 10 years, it has averaged -5.82%. While this does include two years of large deficits as a result of the pandemic, our deficits are still running north of -6% post-pandemic, with the most recent annual deficit running at -6.28% of GDP. As a result of the increasing deficits, the total debt outstanding for the United States has ballooned to $36.2 trillion from $23.2 trillion in 2020 and $5.6 trillion in 2000. Interest payments have also increased significantly over the past couple of years for two primary reasons. First, the exploding total debt levels have naturally resulted in higher interest expense and second, higher interest rates have raised the cost of borrowing for the U.S. Our annual interest expense is now running at just over $1.1 trillion, up from $508 billion in 2020.
Debt & Interest Expense
Deficit as % GDP
The United States has a spending problem, yet neither side of the government is willing to address it. The current tax bill being proposed by the Trump administration does nothing to help reduce spending or increase revenue. In fact, the Committee for a Responsible Federal Budget projects that as the bill currently sits, it will add roughly $3.3 trillion to deficits through 2034, which could jump to as high as $6.2 trillion if certain tax cuts are made permanent and interest expense is included. The increase stems primarily from the extension of the 2017 Tax Cuts and Jobs Act enacted during the first Trump presidency.
How should investors digest the Moody’s downgrade? The Moody’s downgrade by itself is merely symbolic. We expect it should have minimal to no impact on the overall markets. In the short term, we could see interest rates gravitate a bit higher. However, we do not believe the Moody’s downgrade by itself is the reason for this. We believe the realization that the Trump tax proposal does nothing to address the annual deficit, combined with tariffs which could lead to higher inflation, are the main reasons interest rates could gravitate higher in the near-term. We believe that interest rates will remain range-bound over the near-term, with the 10-year yield likely trading in the 4.25-4.75% range, barring any exogenous shock events. We are currently in the middle of that range at 4.55%. While it is clear that the large annual deficits are not sustainable for the United States, we do not believe a crisis is on the horizon in the near term. A combination of economic growth, change in government spending, tax policy and inflation could still help the U.S. “grow” its way out of the debt-to-GDP problems we are experiencing.
Maintaining a well-diversified laddered bond portfolio may help mitigate the risks of fluctuating interest rates. In a recent article, we discussed how adding strategic income securities such as preferred stock to a fixed income allocation at these higher interest rates may bolster a fixed income portfolio over time. As always, please reach out to your Ancora team to discuss your overall portfolio allocation and whether any portfolio adjustments may be appropriate.