On May 16, 2025, Moody’s Investors Service downgraded the U.S. government’s credit rating from Aaa to Aa1, citing concerns about the country’s long-term fiscal strength. This move reflects mounting worries about the fiscal outlook, including persistent budget deficits and rising interest costs. Moody’s also indicated that it does not expect current fiscal proposals to result in meaningful reductions in spending or deficits. Over the next decade, Moody’s anticipates widening deficits driven by increased entitlement spending, while government revenues are projected to remain relatively flat.
While this downgrade is a noteworthy signal, it does not suggest an immediate crisis. U.S. Treasury bonds continue to be among the most liquid and widely held assets globally. That said, there are several potential implications to consider:
- Interest Rates: Yields on longer-term Treasury bonds may rise to compensate for the perceived increase in risk.
- Market Volatility: As seen during previous downgrades, equity and bond markets may experience short-term volatility.
- Currency Movements: While a downgrade can influence the strength of the U.S. dollar, these effects are typically more muted in the short term.
Heritage’s Perspective
In our view, Moody’s downgrade was not entirely unexpected. It was the last of the three major credit rating agencies to maintain a top-tier rating for the U.S. Importantly, credit rating agencies assess the likelihood that a government will default on its debt—not whether it will resort to printing money to meet its obligations. If the U.S. government is unable to reduce deficits by increasing revenue (likely through GDP growth rather than tax increases) or cutting spending, then the remaining option is to monetize the debt by devaluing the currency.
This would likely result in higher inflation. However, predicting the long-term path of interest rates and inflation is inherently uncertain. Potential productivity gains, technological innovation, and other macroeconomic factors could offset some of the inflationary pressure.
Our Approach
Given this complex environment, we continue to focus on asset allocation strategies that can weather uncertainty. The downgrade underscores the importance of:
- Diversification across asset classes and global markets
- Exposure to equities with strong fundamentals, high-quality corporate bonds, and alternative assets such as gold
- Maintaining a long-term investment perspective
As always, we remain committed to guiding clients through theses complexities, ensuring that investment strategies are aligned with both current market conditions and long-term financial goals. Please feel free to reach out with any questions or if you’d like to discuss how this may impact your investment strategy.
