Moody's Downgrade Pressures U.S. Assets, Yields Rise

Investors are facing new challenges as the trading week begins, with U.S. assets under pressure due to Moody's decision to downgrade the United States' credit rating from Aaa to Aa1. This move, announced late Friday, has shifted the focus from tariffs to the nation's debt, raising concerns about the sustainability of the U.S. sovereign debt market.

The downgrade, attributed to the widening budget deficit by successive governments and Congress, has intensified worries on Wall Street. The current discussions in Congress about additional tax cuts, which lack funding support, and the anticipated economic slowdown due to the renegotiation of long-standing trade agreements, have further exacerbated these concerns.

Max Gokhman, Vice Chief Investment Officer at Franklin Templeton Investment Solutions, noted that the downgrade was not surprising given the continuous, cash-strapped fiscal policies. He warned that as large investors, including sovereign and institutional investors, begin to gradually replace U.S. Treasuries with other safe-haven assets, the cost of debt servicing will continue to rise. This could lead to a dangerous bear steepening in U.S. bond yields, further pressuring the dollar and reducing the attractiveness of the U.S. stock market.

Strategists at Wells Fargo predicted in a report to clients that the 10-year and 30-year U.S. Treasury yields could rise by an additional 5-10 basis points due to the Moody's downgrade. If the 30-year Treasury yield increases by 10 basis points, it would surpass 5%, reaching its highest level since November 2023 and approaching the peak of that year, when rates hit their highest since mid-2007.

While rising yields typically boost the currency, concerns over debt could intensify doubts about the dollar. The Bloomberg Dollar Index is nearing its April low, and options traders' bearish sentiment has reached its highest level in five years.

In April, Trump's tariff pledges put significant pressure on the U.S. stock market, prompting many investors to reassess their portfolios. After the U.S. paused tariffs on China, the selling pressure eased, but bond market investors quickly shifted their focus to the U.S. fiscal situation.