Just like consumers, countries get credit scores. On Friday, May 16, the USA’s rating took it on the chin, when Moody’s said: “You’re Downgraded!”. This article puts the ratings downgrade into perspective.
Losing its status as a AAA-rated credit wasn’t a great look for our country.
Moody’s had the following to say about the US credit situation:
- Successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs
- Persistent large fiscal deficits will drive the government’s debt and interest burden higher
- The US’ fiscal performance is likely to deteriorate relative to its own past and compared to other highly-rated sovereigns
The US national debt is currently about $36 trillion, which is the equivalent of about $106,100 for every person in the country. And Moody’s said federal interest payments are likely to absorb around 30% of revenues by 2035, up from about 18% in 2024 and 9% in 2021.
Moody’s recent action moved the US credit rating down one notch, to Aa1 from AAA.
Moody’s describes Aa1-rated debt as high quality and subject to “very low risk”, compared with its highest-quality Aaa rating, which has “minimal risk”.
The USA is now rated one notch below the top tier AAA by all three major credit rating agencies: Moody’s, Standard and Poor’s, and Fitch. These organizations provide credit ratings to bond issuers – larger companies and countries of all shapes and sizes.
S&P was the first to act on the US’ deteriorating financial situation over a decade ago: the agency downgraded the US in August 2011. Fitch downgraded the US in 2013.
The “Sovereign AAA Club”, composed of countries that hold the top tier rating, is now more rarified, with only 10 countries maintaining the gold standard: Australia, Canada, Denmark, Germany, Luxembourg, Netherlands, Norway, Singapore, Sweden, and Switzerland.
However, the downgrade isn’t a death knell for America’s access to credit, or the country’s ability to borrow at relatively attractive rates. US Treasury bond and bill yields (the cost of borrowing for the US government) barely budged on the news.
As of Friday, May 30, the interest rate at which the US government borrows in large quantities, by issuing Treasury bonds and bills, was 4.4%.
Borrowing rates today for the AAA-rated countries are generally lower by about 2 percentage points, on average, than the US. However, this “yield gap” has persisted for some time.
Here’s a chart of the US 10-Year Treasury bond yield from 2006 to the present, showing how interest rates have evolved over the past two decades, with the country’s credit rating across this timeframe, noted in green and red (courtesy of DataTrek).
Source: DataTrek
It’s worth noting that long-term borrowing costs for the US were higher when all three rating agencies had the US debt rated AAA. This was in 2006 – 2007, when 10-year Treasuries often paid +5.0 percent and yields were never below 4 percent.
Fortunately, US credit rating downgrades in the past have not triggered structurally higher interest rates, recession or declining stock prices.
Even so, the Moody’s downgrade serves as a reminder that the US federal government’s debt and deficit trends are troublesome.
In a June 3 article entitled Wall Street is Sounding the Alarm on US Debt, the Wall Street Journal points to the following:
- Annual interest on the US debt is currently above $1 trillion
- The tax-and-spend legislation currently being debated in Congress would add about $3 trillion to the national debt over the next decade ($5 trillion if certain features were made permanent)
- Federal interest payments this fiscal year will be more than the defense budget; or more than Medicaid, disability insurance, and food stamps combined
It’s particularly difficult for individuals who are careful and prudent when managing their own personal financial situations to imagine that such large fiscal imbalances can continue indefinitely.
As a country, we are moving closer to a point when uncomfortable actions likely will be necessary – either through significant reductions in government programs to reduce spending, or by sizable tax increases, or via some combination of spending cuts and tax hikes.
-RK