What investors thought was going to be a nice start to a weekend in May got turned around with a late Friday announcement that Moody’s had just downgraded the U.S. long-term credit rating. Given the current uncertain and volatile investment backdrop for investors, the initial early reactions of selling Treasuries were to be expected. However, this is where one needs to step back and put this announcement into perspective.

The Facts

• Moody’s downgraded Treasuries (UST) one notch to Aa1 from AAA and updated its outlook to stable from negative.
• This was not a surprise move at all, as Moody’s telegraphed it in a relatively recent report and had the outlook already at negative, typically a precursor to a potential downgrade.
• USTs were already officially not AAA after Fitch’s downgrade in 2023, so it just brings Moody’s in line with S&P and Fitch…one notch below AAA.
• As far as the potential for further credit rating agency action, all of the big three (Moody’s, S&P, Fitch) now have Treasuries at a stable outlook.
• A “stable” outlook usually becomes “negative” before another downgrade occurs.

Market Reactions

• When S&P downgraded the U.S. in August 2011, Treasuries were viewed as a traditional hedge for “risk-off” trading. As a result, the UST 10-Year yield actually fell -24 basis points (bps) in “day-after” trading due to the knee-jerk selling in the equity market.
• When Fitch downgraded the U.S. in August 2023, the UST 10-Year yield rose a modest +6 bps in “day-after” trading.
• As of this writing, the Moody’s downgrade initially resulted in a +6bp–7bp increase in the UST 10-Year yield, much like the Fitch episode, before finishing actually 3bps lower in “day-after” trading.

No “Selling America”…TINA for Treasuries

• Remember TINA (there is no alternative) for stocks? The same concept applies for foreign Treasury holders and where to invest their U.S. dollars.
• The total amount of marketable Treasuries outstanding is more than 3.2x the size of the entire global Agg AAA universe: $28.6 trillion vs. $8.9 trillion.
• Here’s a sampling of other sovereign debt countries with AAA ratings: Germany, Netherlands, Switzerland, Singapore, Australia, Denmark, Sweden, Norway.
• Germany recently voted for a massive increase in government borrowing to alter its “debt brake,” a rather visible shift in its own fiscal outlook.
• Bottom line: global investors are still going to buy Treasuries.

Conclusion

As we’ve seen after the two prior downgrades, the fundamentals (econ/inflation data) and Fed policy will ultimately determine the direction and magnitude of yield movements, and we see no difference this time around.