Moody's Negative Outlook: Navigating the Storm in the US Economy
As the closing bell echoed on Friday, a seismic shift reverberated through the financial world: Moody's Investors Service had altered its outlook on the Government of the United States from stable to negative, citing increased risks to fiscal strength. This unexpected move by the credit rating agency has triggered a flurry of discussions among analysts, investors, and market participants.
Moody's decision comes at a precarious time, with the looming threat of a government shutdown and funding secured only until November 17. The agency, concerned about heightened risks to fiscal strength, points to the need for adequate budgetary policy measures against the backdrop of higher interest rates. The trouble is compounded by ongoing political polarization in Congress, raising doubts about reaching a consensus on a fiscal plan.
The timing aligns with a trend seen in August when Fitch downgraded the US long-term foreign-currency issuer default rating. Moody's is now the sole major credit company maintaining a top rating in the US, with S&P Global Ratings having stripped the country of its total score in 2011.
The implications of this shift are significant, sparking discussions about the potential impact on investors and market dynamics. While Moody's negative outlook signals concerns about fiscal risk, experts note that the effect on banks and institutional investors appears limited due to the established use of US Treasuries as collateral and regulatory assets.
The downgrade raises questions about alternatives to Treasuries and prompts consideration of the evolving market dynamics in response to these credit-rating changes. Despite criticisms and disagreements, Moody's shift is a stark reminder of the rising fiscal risks and challenges facing the United States.
Following the announcement, Ten-year Treasury note futures experienced a decline, hitting fresh session lows, while the yield on US ten-year Treasuries rebounded to 4.65%, matching the earlier session's highs. As the markets brace for Monday's opening, a bearish trend is anticipated, reflecting the apprehensions generated by Moody's outlook.
It's essential to recognize that government deficit spending generates money in the private sector, unlike household finances. While concerns about rising government interest payments are valid, the US faces a nuanced economic landscape where servicing interest doesn't necessarily conflict with investing in the real economy.
Despite the rating adjustment, the fundamental attributes of US Treasuries, including high ratings, liquidity, and a robust repo market, remain intact. Commercial banks, major Treasuries buyers, utilize them for regulatory purposes, collateral, and hedging interest-rate risk, with the Basel regulatory framework mitigating the downgrade's impact on capital requirements.
Pension funds and FX reserve managers, other significant purchasers of Treasuries, may see minimal material impact due to their strategic use for long-duration matching and collateral. The downgrade prompts reflections on alternatives to Treasuries, including considerations of Japan's government bonds and Europe's bond market.
In market dynamics, a measured approach is crucial, focusing on the rate of change and avoiding overinterpretation. US Deputy Treasury Secretary Wally Adeyemo criticized the downgrade by Moody's, asserting that the US maintains its AAA rating, emphasizing the strength of the American economy and the global prominence of Treasury securities as safe and liquid assets.
The economic landscape is poised for further uncertainty as the downgrade intersects with other challenges. Existing corporate debt faces a reset at higher rates, and the looming unemployment rate, coupled with an inverted yield curve, raises concerns about a potential deep recession. Government spending, often seen as a temporary band-aid, is steering the US into a hazardous spiral.
In this context, Janet Yellen's cryptic warning about China reducing its Treasury holdings is significant. The potential fallout includes:
Rising yields.
A nosedive in bond prices.
The possibility of China and Japan divesting their US debt holdings.
The US now faces a critical juncture, balancing the demands of two wars and extensive global military commitments with economic stability. The excessive spending, rather than bolstering the real economy, distracts from underlying issues within the country. As the nation navigates this tumultuous economic brinkmanship, the implications of Moody's negative outlook underscore the need for thoughtful and strategic decision-making in the face of growing fiscal challenges.