Moody’s U.S. Credit Downgrade Might Seem Unimportant But It’s Bad News

The U.S. has been ignoring its fiscal condition and its credit rating for decades. Even now that Moody’s, following Standard & Poor’s (technically, S&P Global these days) and Fitch’s Ratings, downgraded the U.S. credit rating from the top AAA to AA+, many people won’t care. Nothing may happen immediately, meaning that politicians might not act, thinking that all will be well.

In the short run, it might seem that way. In the long run, probably not. The drop in rating is ultimately important in itself, but the true issue is how the country treats its budgets and debts. I asked for insights from people in the investment world who understand the meaning and implications.

Looking For Trouble For 27 Years

Ali Meli, founder, chief investment officer, and managing partner of Monachil Capital Partners said the “downgrade was justified and overdue” because the country’s “annual budget deficit have been inconsistent with a AAA rating for at least 27 years, since 2008.” Meli spent close to 15 years at Goldman Sachs as a partner and one-time global co-head of the Structured Finance, Investing, and Lending group. He was heavily involved in shorting the housing market prior to the 2008 market collapse.

“The downgrade by Moody’s simply reflects what the other agencies have reflected in their ratings — that the level of US borrowing and spending poses some concerns in the long-term,” said Ian Toner, chief investment officer of Verus Advisory, in an email to me. The firm provides investment management to large pension funds. They understand how markets work and react, and they also understand risk.

Interest Rates On Debt

The spending issues have also undertaken an unfortunate positive feedback loop. The cost of debt service is currently more than a trillion dollars a year. It becomes increasingly expensive every year to handle the interest on the debt owed, digging the hole deeper.

Toner said that there might be “small short-term market reaction but it’s unlikely that it will be material.”

Well, other than perhaps interest rates, according to John Lekas, president, chief executive officer, and senior portfolio manager at Leader Capital Corp., which has about $1 billion in assets under management. He said that “the US Treasury will have to ultimately pay a higher interest rate to pay for the lower dollar.” Lekas is suggesting that the value of the dollar will keep falling as it has generally been since the beginning of the year.

It’s not in horrible shape, as data from the Federal Reserve Board of Governors, via the Federal Reserve Bank of St. Louis, suggests. The graph below shows what is called the Nominal Broad U.S. Dollar Index, which is a weighted average of foreign exchange values against other major currencies.

The value is still historically strong, and there are some trade advantages in a somewhat lower exchange value because it makes it easier for other countries to buy U.S. goods. Except for the tariff-infused trade wars that have created intense tensions between the U.S. and many other countries, including virtually all of our top trading partners.

Congress Needs To Take Action But History Says It Won’t

Virtually everyone agreed that, for now at least, the dollar will remain the dominant reserve currency and U.S. Treasury instruments, the favored safe parking spot. While that may sound reassuring, it’s because there is no viable current alternative.

Ultimately, Congress will need to do something. “The bigger wild card is political; lawmakers could pivot to revenue raisers (hello, tariffs) or austerity theatrics that unsettle supply chains more than the rating cut ever will,” wrote Michael Ashley Schulman, chief investment officer for a multifamily wealth management firm in Southern California.

Or they could do as they’ve done for generations now, which is nothing other than even when they claim to be ruthlessly cutting the budget, to actually make the debt worse because they focus on tax cuts, and we’ve seen for decades what they tend to do.