Moody’s downgrades US credit rating over mounting debt, fiscal gridlock

Moody’s Ratings stripped the United States of its last top-tier credit rating on Friday, downgrading its long-term issuer rating from Aaa to Aa1. The move reflects mounting concern about America’s ballooning debt and structural fiscal deficits, which the agency warned are on an unsustainable trajectory.

The downgrade places Moody’s in line with its two major counterparts—S&P and Fitch Ratings—which previously downgraded the US sovereign rating in 2011 and 2023, respectively. With the move, all three top credit rating agencies now assess US government debt below the highest grade.

Although Moody’s affirmed that the US retains significant credit strengths—including its resilient economy, deep capital markets, and the global dominance of the US dollar—it said these no longer fully offset the weakening of America’s fiscal health. The agency simultaneously changed the outlook on the rating to “stable”, suggesting no further immediate downgrade is expected.

In its statement, Moody’s cited the failure of successive US administrations and Congress to agree on meaningful fiscal reforms, describing the trend of persistent annual deficits as a key driver of the downgrade.

“We do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration,” the agency said.

The rating agency projects that the federal budget deficit will grow from 6.4 per cent of GDP in 2024 to nearly 9 per cent by 2035, driven by rising interest payments, increased entitlement spending, and relatively weak revenue generation.

Without reforms, the federal debt burden is expected to rise to 134 per cent of GDP by 2035—up from 98 per cent today—marking a sharp increase that would bring it close to post-World War II highs.

Moody’s flagged the possibility that extending the 2017 Tax Cuts and Jobs Act, a central goal of the Republican-controlled Congress and President Donald Trump, would add about $4 trillion to the federal primary deficit (excluding interest payments) over the next decade. That alone, Moody’s said, would materially worsen debt affordability and strain fiscal space further.

The agency noted that mandatory spending—including social security, medicare, and interest payments—is projected to account for nearly 78 per cent of total federal spending by 2035, up from 73 per cent today. Interest payments, in particular, are set to consume 30 per cent of all government revenue by 2035, compared to 18 per cent in 2024 and just 9 per cent in 2021.

What will be the impact?

Though largely expected, the downgrade had an immediate, if modest, impact on financial markets. Yields on 10-year Treasury bonds rose to around 4.49 per cent in after-hours trading, while ETFs tracking longer-term treasury debt fell roughly 1 per cent. The broader equity market also responded, with the S&P 500 ETF declining 0.4 per cent in post-market trading.

Market analysts said the downgrade could push up borrowing costs at the margin, as investors demand higher yields for holding US government debt. Others suggested the symbolic nature of the downgrade might have a limited effect due to the entrenched role of the US dollar and treasuries in global finance.

Still, the move highlights rising concerns about the sustainability of US debt and the political dysfunction that undermines efforts to address it. The announcement came shortly after the GOP-led House Budget Committee failed to advance a major tax-and-spending bill—one that aimed to extend the 2017 Trump tax cuts. The failure was due to opposition from hardline Republicans demanding steeper spending cuts.

Moody’s downgrade also comes amid a wider debate over whether the US is losing its traditional fiscal discipline. Treasury Secretary Scott Bessent recently warned Congress that the country’s debt trajectory was “unsustainable,” adding that a crisis could involve “a sudden stop in the economy as credit would disappear.”

Concerns persist

Moody’s emphasised that US institutions, including the Federal Reserve and the constitutional separation of powers, remain strong and are key stabilising factors. However, the agency noted that recent political dysfunction has hampered the policymaking process and created uncertainty over the government’s ability to enact long-term fiscal reforms.

“Successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs,” Moody’s wrote. It warned that without bipartisan action on spending and revenue, the situation would continue to deteriorate.

Analysts also warned that continued reliance on foreign capital to fund US debt—combined with declining demand for treasuries and heightened geopolitical tensions—could eventually erode investor confidence.

Although Moody’s still sees the US dollar as the dominant reserve currency for the foreseeable future, any shock that triggers a rapid investor pullback could deepen fiscal risks and accelerate the debt crisis.

Looking ahead

Moody’s stated that the US still has time and institutional capacity to reverse its fiscal trajectory, particularly if bipartisan reforms can be enacted to increase revenue or curb spending growth. A credible long-term fiscal plan could eventually lead to an upgrade in the rating, the agency said.

On the other hand, a faster-than-expected deterioration in debt metrics—or a significant erosion in policy credibility and investor confidence—could prompt further rating actions in the future. While the current rating outlook is stable, Moody’s made clear that risks remain tilted toward fiscal deterioration unless political leaders make difficult decisions soon.

In the absence of such action, the downgrade stands as a stark warning: the world’s largest economy can no longer count on its historical fiscal reputation alone to preserve its top credit standing.