Moody's Downgraded U.S. Debt: Does It Matter?

On Friday, May 16, 2025, Moody's Ratings downgraded its rating on U.S. government long-term debt from its highest rating of the next highest rating of Aa1. The move was particularly significant because Moody's was the last of the Big Three credit rating agencies to maintain the triple-A rating for U.S. debt. S&P Global Ratings made a similar downgrade in 2011, and Fitch Ratings did so in 2023.

The reason for the downgrade was the same for all three agencies — excessive, growing debt in relation to revenues. Moody's indicated that its recent action was driven by the long-term trend of "large annual fiscal deficits and growing interest costs" coupled with the lack of potential relief in sight. "We do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration." The agency pointed specifically to the current effort in Congress to extend provisions of the 2017 Tax Cuts and Jobs Act, which it estimated would add about $4 trillion to the federal primary deficit (excluding interest payments) over the next decade.

For perspective, the Congressional Budget Office projected in January 2025 that federal debt held by the public would grow from 100% of gross domestic product (GDP) in 2025 to 118% in 2035, the largest percentage in U.S. history. This projection assumed that the 2017 tax cuts would not be continued and would thus increase revenue, which does not appear likely.

Still-stable securities

Moody’s announcement briefly pushed Treasury yields higher. In theory, investors demand higher interest rates when risk increases. Despite the downgrade, investors do not expect a default. The federal government guarantees the timely payment of principal and interest on U.S. Treasury securities.

The U.S. dollar will likely remain the world’s dominant reserve currency for the foreseeable future. Nations, institutions, and individuals will continue to hold U.S. Treasury securities as a result.

Moody’s emphasized the unique strength of the U.S. economy. The agency noted its large scale, high average incomes, strong growth potential, and history of innovation. These factors support long-term productivity and GDP growth. Moody’s expects short-term growth to slow as the economy adjusts to higher tariffs. However, it does not anticipate significant long-term damage to growth.

Some experts argue that U.S. government debt is so unique that credit ratings have little relevance. Rules governing certain investment funds support this view. A downgrade often restricts how other countries’ bonds can be used. U.S. Treasury securities, however, typically retain their status regardless of rating.

Higher yields

Even so, some investors may approach U.S. securities more cautiously. This caution could keep yields slightly higher than they would have been without the downgrade. Yields were already elevated due to other pressures. These include a high federal funds rate and economic uncertainty tied to tariff policy changes.

Those factors, along with federal budget developments, will likely remain the main drivers of Treasury yields.

Higher Treasury yields benefit investors who seek stable income. They can harm consumers, however. Rates on some consumer loans move with Treasury yields. Thirty-year fixed mortgage rates are a notable example.

The federal government may face the greatest impact. It must devote a growing share of revenue to interest payments. As rates increased during the Fed’s inflation fight, interest costs rose sharply. They increased from about 9% of revenues in 2021 to 18% in 2024. Projections show they could reach 30% of revenues by 2035.

Good News and Bad News

The good news is that the Federal Reserve can generate funds, essentially "printing money" electronically, to ensure the government can pay its debts. This is why Treasury securities are still considered the world's most stable investment. But the current path of ever-higher deficits is a slippery slope, and lawmakers face hard choices to steady the U.S. fiscal outlook.

There is always talk about cutting spending, and the Trump administration is making some efforts to do so. However, the impact of these cuts on the deficit and debt should be relatively small. About 60% of the U.S. budget in fiscal year 2025 is mandatory spending, including Social Security and Medicare. Only 26% is discretionary spending, including 12% for defense, which few want to cut. That leaves 14% for possible budget cuts, much of which pays for programs that many Americans value. The rest of federal spending pays interest on the national debt.

Any substantive fiscal fix will have to include additional revenues, but raising taxes is always difficult politically, and a major economic boom that would bring in more revenue at current tax rates seems unlikely, based on current projections.11 The new tariff program is intended in part to help raise revenues, but it is too early to know whether that will happen.

For now, the credit downgrade should have little or no effect on the U.S. economy and is unlikely to require changes to your investment strategy. Other factors will continue to drive the economy. As always, a wise investment strategy would be designed to weather economic changes and focus on personal goals, time frame, and risk tolerance.

The principal value of Treasury securities fluctuates with market conditions. If not held to maturity, they could be worth more or less than the original amount paid. Projections are based on current conditions, subject to change, and may not come to pass.

IMPORTANT DISCLOSURES

Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual's personal circumstances.

To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.

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