On Friday, May 16, 2025, Moody’s became the last of the three major credit rating agencies to downgrade U.S. sovereign debt, lowering it from AAA to Aa1. This move, while significant in appearance, was widely anticipated following earlier actions by Standard & Poor’s in 2011 and Fitch in 2023. As the final agency to make the change, Moody’s downgrade rounds out what has become more of a symbolic shift than a seismic market event.
How does a Change in our Credit Rating Affect the Stock Market?
Despite the headlines, previous credit downgrades have shown limited impact on equity markets. For equities, following S&P’s August 2011 downgrade, the S&P 500 Index fell 1.9% in the first month, only to rally 18.5% over the next year. Similarly, after Fitch’s downgrade in August 2023, the S&P dipped 1.1% over a month but was up 20.8% within a year. As such, research supports the consensus view that these downgrades carry little influence on equity markets over the medium- to long-term.
How does a Change in our Credit Rating Affect the Bond Market
The U.S. credit rating downgrade is unlikely to materially alter the fundamental dynamics of U.S. debt markets either. If there are any marginal increases in borrowing costs they will be modest, as long-term interest rates are primarily driven by broader economic fundamentals rather than credit ratings alone.
Investors are also watching the 30-year Treasury yield, which has crossed the 5% threshold, a level seen several times recently, including in January of this year and October 2023. While the 5% mark is noteworthy, it isn’t unprecedented or inherently alarming. At Condor Capital, we maintain a disciplined approach to fixed income portfolio management, carefully controlling duration exposure. Our strategies generally avoid extending to the 30-year end of the curve, except for modest allocations through actively managed funds. As a result, our clients’ bond portfolios are positioned to be relatively insulated from movements in the longest-term yields.
From a yield curve perspective, the relationship between the 10-year (currently around 4.5%) and the 30-year (at 5%) suggests that markets are demanding only a minimal premium (just 0.5%) for an additional two decades of duration risk. This spread doesn’t indicate heightened concern over the U.S.’s creditworthiness or ability to meet its obligations.
The Global Context
Finally, it is also crucial to recognize the unique position the United States occupies in global finance. No other sovereign debt market comes close to matching the scale and reserve currency status of the U.S. As such, the U.S. enjoys an extraordinary funding advantage, with both domestic and international demand for Treasuries consistently surpassing the supply. This global appetite for Treasuries acts as a buffer against the kinds of disruptions that smaller, less liquid markets might face in the wake of a downgrade.
For example, Switzerland’s sovereign debt is AAA-rated, making it now higher-rated than ours. Yet in the face of the U.S. downgrade, we have not seen a mass exodus of investors from the U.S. to Switzerland. In addition to not having the desire to head for the exits, large holders of U.S. debt would not really have the ability to do so either. Even among AAA-rated countries like Switzerland, there simply isn’t enough debt issued to absorb the trillions currently invested in U.S. Treasuries. Major holders like Japan, the U.K., and China own a combined $2.5 trillion of American bonds, and the liquidity does not really exist for them to flood other smaller debt markets with that amount of scale even if they desired to.
What This Means for You
In conclusion, while Moody’s downgrade adds another chapter to the story of U.S. credit ratings, history shows us that such changes often have more bark than bite. These downgrades do speak to real concerns over the size of the deficits and debts the U.S. is currently running in our national budget, but they are far from representing any kind of tipping point. The strength and scale of the U.S. Treasury market combined with prudent fixed income management help ensure that the practical impact for most investors, particularly those with well-structured portfolios, remains limited.
