The US Dollar (USD) is softer and longer-term yields are higher with the S&P future down 1.0% suggesting the potential for a day of triple selling of US assets that is being driven by the decision of Moodys to downgrade the sovereign rating of the US from the top Aaa rating to Aa1. The downgrade was coming and Moodys was the last of the big three to lower the sovereign rating of the US from the top level. S&P did it first back in 2011 followed by Fitch in 2023. Moodys had recently provided an update on its position of the US that signalled a downgrade was coming, MUFG’s FX analyst Derek Halpenny notes.
Moody’s downgrade highlights US fiscal risks
“Moodys cited ‘the increase over more than a decade in government debt and interest payment ratios to levels that are significantly higher than similarly rated sovereigns’. It also added that it did not believe multi-year reductions in deficits were likely from current fiscal proposals under consideration. The downgrade came just before a deal over the weekend that resulted in the House Budget Committee approving President Trump’s tax and spending package. The deal was reached following agreement with Republican hardliners for quicker cuts to Medicaid health coverage and a faster phase-out of clean energy tax breaks and subsidies. Challenges remain and further changes to the bill seems likely with Senate opposition to elements of the bill likely to be the biggest issue ahead. The Moodys downgrade will further reinforce fiscal hawks of the needs to offer a credible, achievable bill.”
“This downgrade, while the final one from the big three ratings agencies could well prove the most significant. Episode of triple selling of US assets have been few and far between in recent years. Our analysis of these episodes tend to point to further US dollar selling ahead. The episode in April on such a scale was the first since 2001. The current bill agreed in the House over the weekend, even assuming it is toned down, will ensure the US continues to run deficits much higher than in other major developed economies and in the region of between 5%-7% of GDP. That will considerably increase the risk of counter-productive moves higher in yields that ultimately crowds out the growth benefit. The main cost of the bill remains extending the current tax cuts and is therefore more about avoiding a big tax hike that hits growth than providing a boost to growth.”
“We published a new trade idea of short USD/JPY on Friday that was of course prior to the Moodys’ downgrade. Risk aversion is higher now than expected with Asian equities mostly lower. A steeper yield curve in the US and continued questions over confidence in US assets will reinforce downside momentum in USD/JPY. BoJ Deputy Governor Uchida repeated again today the intention of the BoJ to hike the policy rate if the BoJ’s economic outlook is realised.”