Due to concerns over the country’s $ 36 trillion debt pile, Moody’s downgraded its credit rating last week. The action could stifle President Donald Trump’s efforts to reduce taxes and send ripples through the financial markets.
The US government’s credit score was dropped from the pristine Aaa to Aa1 by the Moody’s rating agency. It cited rising interest rates and debt costs that were “significantly higher than sovereigns with comparable ratings””.
The US credit score was downgraded by rating rival Fitch, which had earlier downgraded the US credit score in 2023. After Standard & Poor’s did so in 2011, Fitch was the second major rating agency to remove the US’s AAA rating.
Credit ratings are used by investors to assess a company’s and government’s risk profile. The higher a borrower’s financing costs are the lower a borrower’s rating is.
What justifications were given by Moody’s for the downgrade?
According to a news release released last week, “Successful US administrations and Congress have failed to reach agreement on measures to stop the trend of large annual fiscal deficits and rising interest costs.”
“Over the past decade, US federal debt has steadily increased as a result of ongoing fiscal deficits. Federal spending has increased while government revenues have decreased as a result, it said.
Moody’s downgraded Washington for the first time since 1949, the year it first started grading US government debt.
Trump has stated he will balance the budget since his January return, but Treasury Secretary Scott Bessent has repeatedly stated that the administration wants to lower its borrowing costs.
However, Trump’s initial goals were far short of what Elon Musk’s Department of Government Efficiency attempted to cut spending. Washington’s current debt rate is currently around $1 trillion per three months.
In the meantime, it is unclear whether tariff-based efforts to increase revenues, which raised concerns about a global slowdown and trade war, will succeed. The majority of economists believe they won’t.
US government bonds have been the “risk-free” benchmark for other financial assets for decades. However, that is being called into question more frequently.
How severe is the US debt issue?
A staggering 16 percent (or $684bn) of tax revenues were used this year to pay debt interest payments, according to data from the US Department of the Treasury. By contrast, that figure is closer to 4% in Germany.
Looking ahead, Moody’s predicted that by 2035, the US federal deficit would increase to 9 percent of GDP, up from 6 percent in 2024, “primarily due to increased interest payments on debt… and relatively low]taxes.”
By 2035, the federal debt burden, according to the report, will be 134 percent of GDP, up from 98 percent in 2024. In context of the COVID-19 pandemic, the debt-to-GDP ratio reached a record high of 133 percent in 2020.
Moody’s maintained that the US still has “exceptional credit strengths” in terms of size, resilience, and dynamism, and that the US dollar continues to be a major reserve currency.
What has been the administration’s response?
White House spokesman Kush Desai said in a statement that “If Moody’s had any credibility, they would not have remained silent as the fiscal disaster of the past four years]as it unfolded”
Moody’s downgrade was seen as politically motivated by The White House. Mark Zandi, the head economist for Moody’s, is a Trump critic, according to White House communications director Steven Cheung.
What’s the background like?
Trump is urging members of Congress to pass legislation that extends the 2017 tax cuts that were proposed. His signature first-term accomplishments were those that cut corporate and individual taxes.
A bill to extend those tax cuts failed to pass a procedural hurdle on Friday as some Republicans in the House of Representatives demanded more spending cuts before vetoing Moody’s recent downgrade.
The holdouts then dropped their opposition and allowed it to pass through committee late on Sunday. The full chamber is now one step closer to passing the tax proposal.
According to Moody’s, the fiscal proposals being considered were incompatible with a steady decline in the deficit and ongoing discussions about reducing taxes, which would increase the debt burden by 134 percent of GDP over the next ten years.
Senate Democratic Leader Chuck Schumer said on Friday that “Moody’s downgrading of the United States’ credit rating should serve as a wake-up call for Trump and congressional Republicans to put an end to their careless pursuit of their deficit-busting tax giveaway.”
I’m not holding my breath, sadly.
What results did the downgrade produce?
Fears that a large investor will reevaluate US sovereign debt were exacerbated by Moody’s downgrade. As asset prices decline, so does the demand for them. Returns from investors’ loans to the government are then changed, with the opposite outcome.
More than 4.5 percent of benchmark 10-year yields increased on Monday, influencing both corporate and consumer interest rates. Since then, they have decreased a little. Yields increased for longer-dated 30-year bonds as well.
US stock markets were jittery on Monday despite Moody’s announcement, but they have since largely recovered. Gold, on the other hand, increased by almost 1% to $ 3,220 an ounce before falling off on Tuesday and Wednesday.
The US dollar’s value also decreased against a range of other currencies. For instance, the British pound increased to $1.35 from its previous high against the greenback at the start of May.
What makes it important?
Because commercial banks use government bond yields as a benchmark for setting their own interest rates, lower credit ratings typically lead to higher bond yields, which will increase interest rates on everything from mortgages to car loans to credit card debt.
Americans, who are among the world’s most deserving of all credit, are in need of this. According to the International Monetary Fund, US household debt in relation to GDP reached 73 percent in 2023. Household debt-to-GDP ratios in excess of 100% are found in Canada, Australia, and Switzerland.
As the government’s spending increases for rising debt repayments becomes more expensive, the US government will have less money for public programs like Social Security, healthcare, and defense.
Washington could raise taxes to reduce its debt in order to generate more income. However, Trump seems to be moving in the opposite direction, lowering both public spending and taxes.
Source: Aljazeera
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