Questioning US credit quality

When ratings agency Standard and Poor’s downgraded the US from its top-tier credit rating, during the debt-ceiling standoff in the summer of 2011, I was a Treasury official in the Office of Debt Management. I hoped it was an error, and that the US would maintain its other sterling ratings, which I knew to be emblematic of the wealthiest, most dynamic economy in the world. However, since then, other ratings agencies have followed suit — Fitch downgraded the US in 2023, and Moody’s, the last bastion, more recently, in May of this year.

Why should investors care about this third and final downgrade? What else does it speak to? In this piece, we explain just what this deterioration of US creditworthiness means for investors.

Decoding the Moody’s downgrade

The Moody’s downgrade is wrapped up in several complex issues, including:

• Reserve currency status
• Debt sustainability
• Domestic policymaking
• Whether there exist foreign alternatives to the US dollar (USD)

While Moody’s cited high levels of government debt and rising interest costs as the basis of its action, the downgrade also reflects a broader erosion of US policymaking mechanisms and prestige in the global marketplace. Before the current administration took office, domestic policymaking was already dysfunctional, with multiple debt-ceiling standoffs and the occasional government shutdown. Recent policies may have tipped these dynamics over the edge.

Should investors fear further ratings decreases? While Moody’s has said it expects to maintain the revised rating level, the agency did mention that breaking institutional relationships — something that could realistically come about in response to more unconventional policymaking — could be a cause for reevaluation.

This said, The US is still the largest capital market in the world, and the size, depth, and liquidity of its Treasury market — approaching US$25 trillion — dwarfs other global sovereign markets. The relative size of the tradeable Treasury market should be considered a power that wraps around the operation of global financial markets.

Unpacking the question of Fed independence

The downgrade and attendant reputational concerns coincide with questions of US Federal Reserve (Fed) independence. The current administration’s push for short-term interest-rate cuts may come with a price if the Fed, which seeks to balance growth and inflation, deviates too far from its established playbook.

What’s more, Fed Chair Powell (who has often been at odds with the president about the best direction for rates), is likely to be replaced in May 2026. Other board members will turn over next year, too, opening up the possibility of a board more aligned with the administration and less independent from the executive branch of the US government.

But what does this mean for investors? If the president keeps pushing for rate cuts and the Fed’s independence is diminished, the bond market will react accordingly. Premia, or additional compensation required to hold long duration securities, will likely increase. There’s also the longer-term story here surrounding issues of regulation, supervision, and central bank architecture that bears monitoring.

Wondering whether the USD can remain a reserve currency

Another factor weighing on US credit quality is the USD, which has turned in relatively weak performance year to date, driven in part by self-inflicted capital outflows resulting from policy uncertainty. A continued rut in dollar returns could signal declining US exceptionalism, which would put the dollar’s historic status as a safe-haven currency at risk. The greenback has long served as the world’s primary reserve currency, which means it’s the chosen denomination for pricing and settling international in commodities and a wide range of goods. If the USD lost this status, it would reflect a structural decline, reshaping portfolio currency-hedging needs and accelerating a rotation out of US risk assets, such as equities, while also substantially changing the standard of living within the US for the real economy.

While this risk is certainly worth understanding and watching, investors will do well to maintain perspective. Despite recent USD performance, it remains the preferred invoicing currency for as much as 40% of global trade (even in instances when the US isn’t the final destination of said trade).¹

Identifying the investment implications

Questions of US creditworthiness, Fed independence, and USD reserve currency status are significant and possibly unnerving given the centrality of the dollar to the global financial ecosystem. They’re very worth paying attention to, but should inspire thoughtful preparedness and diversification, rather than knee-jerk allocations. From a fixed income perspective, three things investors might do to mitigate the pressures arising from deteriorating US creditworthiness include:

• Diversify outside of the US – Global sovereign and currency strategies that are less constrained by benchmarks can help navigate late-cycle and tariff-driven volatility. Many of these markets yielded zero several years ago, but now, because of economic and policy changes, they’re in positive yield territory. This can be executed via traditional global bond markets or through more dynamic hedge fund allocations.
• Consider emerging markets (EM) local currency debt – The asset class offers attractive yields compared to developed markets, and stable inflation across many EM countries enables their central banks to cut policy rates, which represents a cyclical tailwind and could pair well with a more globalized fixed income strategy. It’s worth noting that this is a return-seeking strategy and should not be used as a replacement for developed market sovereign or US Treasury allocations. It may make sense to have an active manager consider the trade-offs, which leads us to the next point.
• Lean into an active approach – During times of anxiety and uncertainty, we believe there’s a strong case to be made for active management, which tends to be nimbler and more adaptable than passive.