Moody's, the last major rating agency to give U.S. debt a AAA rating, has changed its mind. This decision marks the end of an era.
It provoked a reaction in the financial markets that was as remarkable as short-lived. But behind this apparent flash in the pan lie major debt problems, affecting not only the United States but also the global economy as a whole and likely to weigh on growth in the long term.
Equity markets fairly satisfied
Equity markets - especially in the U.S. - were quick to forget the downgrade of U.S. debt. And with good reason: the decision is not surprising in itself.
The other rating giants have been doing this for a long time. Fundamentally, the downgrade is linked to the White House's desire to win approval for tax reform that will significantly reduce the tax burden on American businesses and households.
In the short term, this is good news: on the one hand, it will increase households' disposable income and, therefore, their ability to spend. This will boost private sector demand and the sales of companies operating in the U.S. market.
At the same time, companies should benefit from the lower tax burden. Profits will rise as a result, as will growth.
Under these conditions, it is difficult to convince the equity markets that this reduction in the tax burden is bad news.
Admittedly, the loss of the AAA rating could well mean higher interest rates and slightly more expensive credit. Therefore, sectors that are highly dependent on financing, such as technology, suffered initially.
But, in the end, in a more buoyant economic climate, this rise in the cost of credit is not likely to weigh on companies or discourage investors. Equity markets are coping very well.
Bonds are worried
Bond markets, however, are looking to take the long term. And here, the news is less reassuring. The U.S. public accounts have deteriorated sharply since the start of the decade, with deficits averaging close to 9% of GDP.
According to the Congressional Budget Office (CBO), the deficit is expected to settle at around 6% of GDP at the start of the next decade and gradually rise to 7.3% by 2055. The CBO was expecting slightly lower deficits in the second half of the 2020s.
Given Trump's tax cuts, investors are likely to be disappointed. In these circumstances, the pressures on bonds are logical. Investors make long-term commitments. They, therefore, want to be compensated for the additional risks they incur by investing their capital, especially over the longest maturities.
So it's no surprise that the U.S. 30-year rate is the most concerned, hovering around the symbolic 5% mark, while the 10-year rate is over 4.5%. Naturally, such expensive credit over a long period would increase the debt burden for governments, households, and businesses and pose greater risks to economic growth—and not just in the United States.
Towards globally expensive credit
The U.S. debt market is the largest and most liquid of all debt markets. The cornerstone of the global financial system is also the benchmark for investors who demand a higher risk premium to invest in emerging markets or offer more advantageous terms to markets that are safe havens, such as Switzerland or Germany.
Yet, on a global level, debt levels continue to rise. The competition to attract capital is therefore fierce, and, given the returns offered in the United States, the others have no choice but to follow suit. Credit looks set to remain expensive for a long time to come, and, just as worryingly, central banks are losing control of the yield curve over the longest maturities.
The European Central Bank has cut its key rates seven times since June 2024, reducing the main rate from 4.5% to 2.4%. At the same time, the 10-year rate has barely moved.
In the UK, rates for the same maturity have risen sharply over the past year despite the Bank of England's three key rate cuts. And what about Japan? The latest issue of long-term debt met with very little demand from investors, and as a result, the country was forced to offer the highest yield ever recorded.
Given the galloping global debt situation, everything leads us to believe that we are heading for a period of relatively high long-term rates, when central banks will be under pressure to intervene once again on the debt markets, buying up longer maturities to provide the various governments with financing at still passable price levels.
Some will cope better than others. For several quarters now, the United States has demonstrated its ability to continue growing despite expensive credit.
In Europe, on the other hand, everyone is waiting for the ECB rate cut to be the elixir that will revive our economies.
We are entitled to doubt their real impact. In Japan, demand was already struggling with cheap credit. The soaring cost of credit will not be a gift to the archipelago.
U.S. markets are still attractive
The equity markets quickly forgot about the loss of the last AAA rating on U.S. debt, preferring to focus on the boost that a lower tax burden would give the economy.
Nonetheless, the decision to downgrade the U.S. rating is another reminder that debt is rising steadily and on a worrying trajectory in the U.S., as in many other major economies. We can, therefore, expect persistently high interest rates over the most extended maturities, with central banks intervening to limit them.
Despite the ups and downs, U.S. debt still has a lot going for it. The interest rate differential between the U.S. and other major regions remains wide. Yields on offer are higher than inflation and, therefore, positive in real terms. Finally, the U.S. economy is coping better than most with this relatively expensive credit.
Therefore, we continue to invest in U.S. bonds in all our portfolios.
The trajectory of the U.S. deficit
(Budget deficit as % of GDP)
Source: Congressional Budget Office (CBO)
Since the start of the decade, the expected trajectory of U.S. government deficits has been catastrophic. This suggests that credit will remain expensive in the United States and elsewhere.