Source: IgniteRatings, X
Moody's has downgraded the long-term issuer and senior unsecured debt rating of the U.S. government from Aaa to Aa1, and adjusted the outlook from negative to stable.
This downgrade reflects the fact that over the past decade, the proportion of U.S. government debt and interest payments has continued to rise, far exceeding that of other sovereign countries with the same rating.
— -Moody's, May 16, 2025
Moody's has downgraded the U.S. long-term credit rating, indicating that U.S. sovereign credit has been removed from the AAA ranks by all major rating agencies. This news was released a few hours after the close of U.S. stocks last Friday and reportedly prompted the U.S. House Budget Committee to quickly advance the 'One, Big, Beautiful Bill' on Sunday night in an effort to minimize potential market shocks.
Setting aside political struggles and the drama of the budget bill, is credit rating still important? Readers may recall that Silicon Valley Bank (SVB) still held an 'A' rating prior to its collapse, and more seasoned readers may not have forgotten the absurdly high ratings given to CDOs, CMOs, subprime mortgages, and Chinese real estate bonds.
For this topic, we have organized key points in an FAQ format:
When has the U.S. been downgraded in the past?
July 2011: S&P
August 2023: Fitch
Will there be immediate technical impacts?
For institutions restricted by ratings that cannot hold non-AAA rated bonds
Due to the scale and irreplaceability of U.S. bonds as an asset class, these institutions typically adjust their internal rules (as has indeed been the case in the past).
Impact on central clearing
The treatment of government bonds as collateral by DTCC and CME is based on duration and bond type to set discounts (haircuts), with less reliance on ratings.
Impact on money market funds
Short-duration allocation has weakened the impact of credit ratings; in fact, even after experiencing downgrades and debt ceiling disputes in the past, the demand for Treasury bills has shown almost no fluctuation.
The long-term reserve asset status of U.S. bonds
In fact, President Trump's tariff policies and global trade restructuring have a more profound impact on global demand for U.S. bonds than any rating agency.
How did the market react in the past?
During the downgrade in 2011, it was the first downgrade and occurred during the initial 'debt ceiling crisis', which shocked the market.
The stock market fell about 20% in July-August, but due to hedging and the ongoing quantitative easing policy at the time, the 10-year U.S. Treasury yield actually dropped 120 basis points after the downgrade (i.e., prices rose).
In August 2023, the downgrade occurred right after the early summer debt ceiling crisis, while the U.S. Treasury was also recovering market liquidity by rebuilding its general account and issuing a large amount of U.S. bonds. At that time, the SPX index fell about 10%, while U.S. bond yields continued to rise by about 50 basis points during the year. Although this credit rating downgrade may have accelerated the relative market movements, overall, it did not fundamentally change the market landscape.
Will this downgrade affect fiscal decisions?
The House Budget Committee did indeed advance the budget on Sunday night, showing some degree of intent to mitigate potential market shocks.
Will there be cuts to dollar spending or a control of deficits? While the downgrade may give fiscal hawks a stronger voice, it is unlikely to change the long-term trend of uncontrolled spending and concerns over unsustainable U.S. bond supply.
This will increase uncertainty regarding the timeline for the final passage of the bill and whether there will be delays, and due to adverse effects on the budget, it may weaken the potential positive effects of tax cuts.
What might the market's response be this time?
In the stock market, given past experience and the rapid rise in the market over the past few weeks without broad leadership, a short-term market reaction is likely to be an instinctive decline.
The bond market's trend is difficult to predict and depends on factors such as the extent of risk appetite decline in the stock market, the contest between fiscal hawks and Trump, whether the Senate can pass the budget before the debt ceiling expires, and whether this incident will affect Trump's 90-day tariff truce agreement.
Overall, U.S. stocks, bonds, and the dollar may face negative risks.
What is the current positioning in the macro market?
Macro funds, systemic funds, and quantitative funds have mostly covered shorts or reduced positions, and some have even turned bullish.
Last week, the market experienced a small '融涨' trend, with traders scrambling to cover short positions, and the NYSE's Advance-Decline Line indicator hit a recent high.
How did the economic data perform last week?
This is quite bad for the bond market.
Despite recent easing of tariff policies, the University of Michigan's consumer sentiment index has still declined significantly.
The overall index has fallen to its lowest point since June 2022, almost approaching its lowest level since the 1980s.
Long-term inflation expectations have risen to the highest level since 1991 (4.6%).
One-year inflation expectations are even higher at 7.3%, the highest level since 1981.
Should the market worry about foreign capital selling?
Let's review the situation over the past few months.
Non-U.S. investors have stopped increasing their holdings in U.S. stock funds since March and have become net sellers of bond funds; this trend may continue in the short term.
However, in terms of actual impact, bank data shows that in 2024, foreign investors held approximately $57 trillion in U.S. dollar assets, a significant increase from $2.2 trillion in 1990. Among these, about $17 trillion is in equity assets and $15 trillion in bonds.
In other words, foreign capital holds about 20% of the total supply of U.S. stocks and 30% of the total supply of U.S. bonds.
This is not a small amount, and it is not feasible to significantly sell off or reduce holdings without affecting the overall capital market structure.
Furthermore, assets are dispersed among different foreign holders; any hasty actions by any party will involve the gaming responses of other participants.
For the stock market, the key still lies in corporate earnings performance, which has been good so far. According to JPM data, the overall earnings of the SPX index exceeded expectations by about 8% in the first quarter, with 70% of companies having reported earnings, of which 54% had revenues above expectations, and 70% had earnings exceeding expectations, while the EPS growth of the Mag-7 reached as high as 28%, far ahead of the index.
In terms of holdings structure (not considering ambiguous offshore structures like the Cayman Islands), the UK, Canada, and Japan are currently the top three holders of U.S. assets globally, and they are also close allies of the U.S. China ranks fourth, accounting for about 4%, significantly lower than the previous group’s 8-9%.
Based on the trends over the past month, Japanese investors have indeed reduced their U.S. bond holdings, but at the same time have significantly increased their U.S. stock holdings, making this more a matter of asset allocation adjustment rather than actual dollarization.
In short, it is unlikely that there will be large-scale capital withdrawals or a shift away from the dollar in the short term.
How is cryptocurrency performing?
Interestingly, even though gold prices have fallen about 7% from their peak, cryptocurrency prices have remained stable throughout the trend.
Unlike the previous months where gold prices and BTC rose in sync, recently BTC has continued to rise while gold prices have weakened, which is also reflected in ETF fund flows.
Gold ETFs have seen outflows, while BTC ETFs have seen slight inflows, and CME's gold and BTC futures positions have shown similar trends.
Overall, as the macro market stabilizes and the depreciation of the dollar is reflected in most asset classes, we expect the correlation breakdown between such micro-assets and relative value opportunities to continue until the next round of significant geopolitical developments materializes.
Wishing everyone successful trading!
