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What Does the Moody's Downgrade Mean?

June 1, 2025 | Commentary

  • The recent Moody's downgrade of U.S. sovereign debt follows similar actions by S&P and Fitch in 2011 and 2023, respectively. The recent media reaction followed past pessimistic lines.
  • Even after the downgrade, U.S. debt poses little risk of default and remains the largest and most liquid bond market in the world. Predictions of global flight from U.S. debt ignore the facts that the debt is still quite strong and there are no practical alternatives in the world.
  • Significant deficit spending in the U.S. has been the norm since the Global Financial Crisis. Since then, debt to GDP has risen from 64% to over 100% and is projected to keep rising. A return toward historical interest rates has raised the share of the federal budget devoted to debt service to 14%, second only to Social Security's 22% among expenditure categories.
  • Despite the rapidly rising federal debt, interest rates have not been pushed higher by "bond vigilantes." This is likely due to fundamental buyers from pension plans and insurance companies along with the Fed's willingness to step into the bond market whenever they see demand falling well short of supply.
  • History has shown that continuously rising debt levels are not sustainable no matter what the recent past suggests. There could be a tipping point where the demand for borrowing exceeds the Fed's ability to keep rates under control, leading to higher inflation and a crowding out of private investment. We are not near that point now, but politicians should not dismiss the possibility in the future.

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