The inevitable

The inevitable happened. Yesterday afternoon, after the market closed for the week to give investors the opportunity to calmly reflect on the news, Moody’s downgraded the US credit rating one notch, from Aaa to Aa1. It’s said that the first cut is the deepest, but this one was expected, and if the fiscal situation doesn’t improve, it won’t be the last one. As you can see on the chart below, the US runs a deficit of around $2Tn a year, which after years, has accumulated into a $37Tn of debt, or 123% of GDP. That is unhealthy and unsustainable, and Moodys just stated the obvious. The interesting part is the timing; before the new tax plan that is being reconciled by Congress is made public, that supposedly, will widen the deficit even more. Perhaps if they had waited until the plan was made public, they would have had to lower the rating two notches, instead of one. This is the opposite of what Secretary Bessent needs to roll over the debt and issue more to cover the deficit, as the yield of our debt will rise, although most of it was probably discounted. This should weaken the dollar too. According to Rogoff and Reinhart, the point of no return for an economy is reached when debt to GDP surpasses 90%. Unless radical measures are taken, nothing will stop this train.

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