How Big a Deal is the Moody's Downgrade of U.S. Credit?

Last week, Moody’s became the last of the three agencies to downgrade the U.S. credit rating. How will this impact investors in the short and longer term?

What Does the U.S. Credit Rating Downgrade Mean for Investors? Another ratings agency has downgraded the U.S. government. Last Friday, Moody’s became the third and final agency to strip the U.S. of its AAA credit rating, following earlier downgrades by S&P in 2011 and Fitch in 2023. Moody’s cited a persistent and widening fiscal deficit, along with the compounding effects of elevated interest costs, as the primary drivers of its decision. According to the agency, “successive U.S. administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs.”1 In other words, Moody’s is telling us something we’ve already known for decades. The reasons Fitch and S&P gave for their downgrades largely mirrored Moody’s reasoning: too much spending, too little revenue, and too little cooperation in Congress to fix the issue. Put another way, ratings agencies give us a reflection of the state of affairs, but they are by no means leading indicators. After all, as seen in the chart below, the U.S. government has only managed to run four budget surpluses in the last 50+ years. The downgrade might be news, but the issue isn’t. Source: Federal Reserve Bank of St. Louis 2 The Market’s Hidden Signals Revealed Moody’s downgrade confirms a problem decades in the making—but markets don’t wait for slow-moving headlines. They respond to shifts in earnings, business activity, and investor sentiment long before the news catches up. Our May Stock Market Outlook Report 3 exposes the real forces moving markets now—and reveals what’s coming next. Inside, you’ll find: Asset allocation guidelines for today’s market environment. Expert forecasts for inflation, rates, and economic trends. Industry tables and rankings to help you spot opportunities. Buy-side and sell-side consensus insights at a glance. And much more! Don’t get left behind reacting to yesterday’s facts. If you have $500,000 or more to invest, download the report now and position your portfolio for what’s ahead! Download our Exclusive Zacks May Stock Market Outlook Report 3 Not only do ratings changes tend to be lagging indicators, but there’s also a long history of ratings missteps over the years. Perhaps the biggest in history came from the 2001 Enron scandal, where the rating agencies didn't downgrade the company until just days before its collapse. There’s also the fact that S&P agreed to pay a $1.5 billion penalty for failing to assess the exorbitant risks present in the subprime mortgage CDO market leading up to the 2008 Global Financial Crisis—a huge miss. Ratings downgrades would matter greatly if they resulted in surging Treasury bond yields, i.e., if they made it more expensive for the U.S. to borrow. But that has not been the case historically. As seen in the chart below, when S&P downgraded U.S. debt in 2011, the 10-year U.S. Treasury bond yield was at roughly 2.5%. It finished the decade below 2%. Source: Federal Reserve Bank of St. Louis 4 Ultimately, bond investors aren’t focused on letter grades—they’re focused on whether they’ll get their money back, with interest. From that lens, the U.S. remains one of the most reliable borrowers in the world. What matters isn’t the absolute size of U.S. debt, but its ability to service that debt. And right now, annual federal tax revenues far exceed interest payments, underscoring our ability to never miss a debt payment. Add to that the global demand for dollar-denominated assets and the sheer scale and diversity of the U.S. economy, and it becomes clear why Treasurys still sit at the center of global finance. Source: Federal Reserve Bank of St. Louis 5 It is important for me to make a distinction in my argument here, however. While I think a ratings downgrade a notch lower from AAA does not have many investment implications, I do believe the long-term issue of consistent deficit spending can and will have negative economic effects if it persists. One key concern is the crowding-out effect. When the government runs large deficits, it typically funds them by issuing more debt. As federal borrowing ramps up, it can absorb a greater share of available capital in the economy, leaving less for private-sector investment. That shift can hinder the growth of businesses, limit innovation, and reduce long-term productivity. Additionally, as debt servicing consumes a larger slice of the federal budget, it can constrain fiscal flexibility. Dollars spent on interest payments are dollars not spent on infrastructure, education, or other areas that support long-term economic health. Over time, if this dynamic continues unchecked, it can dampen potential GDP growth and erode investor confidence in U.S. policymaking—even if default risk remains low. Bottom Line for Investors Investors shouldn’t view the downgrade as an urgent alarm bell. But we should also not ignore the broader message. While Moody’s isn’t telling us anything new, the ratings downgrade does reinforce a longer-term concern: persistent fiscal imbalances. If left unaddressed, this can become a drag on economic growth. The risk isn’t about an imminent inability to pay—Treasury interest payments remain well covered by tax revenues—but about the cumulative effect of rising debt and interest costs over time. If deficits continue to widen and debt service takes up a growing share of federal resources, it could begin to crowd out productive private investment, strain fiscal flexibility, and gradually undermine the foundations of U.S. economic leadership. In that sense, the downgrade is less a shock event and more a warning sign for policymakers on the road ahead. In a market shaped by complex economic forces and long-term fiscal challenges, our May Stock Market Outlook Report 6 connects the dots between key trends, market signals, and underlying risks—helping you cut through the noise and stay focused on what truly impacts your portfolio’s performance and long-term growth. Inside, you’ll find: Asset allocation guidelines for today’s market environment. Expert forecasts for inflation, rates, and economic trends. Industry tables and rankings to help you spot opportunities. Buy-side and sell-side consensus insights at a glance. And much more! If you have $500,000 or more to invest and want to learn more about these forecasts, click the link below to get your free report today! 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