Why Investors Shrugged When Moody's Threatened a US Credit Rating Downgrade

Traders work on the floor of the New York Stock Exchange (NYSE) on November 15, 2023 in New York City. The Dow was up again in morning trading after news of lower than expected inflation readings encouraged investors.

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Key Takeaways

  • When Moody's downgraded the outlook for the U.S. credit rating last week, markets moved little in response.
  • The downgrade reflected growing U.S. government deficits and a lack of political will to rein them in, a problem that was already well known.
  • Two of the three credit rating companies have already downgraded U.S. debt from its gold-plated AAA status.
  • The U.S. losing its last AAA rating would be a symbolic milestone, one economist said.

Last week, when Moody’s Investor Service said the U.S. government was at risk of losing its last gold-plated credit rating, markets met the news with a yawn.

On Friday, the credit ratings company downgraded its outlook for the U.S. government’s AAA-rated credit to “negative” from “stable.” The company indicated the U.S. government was at risk of dropping a notch because of high budget deficits and Congress’s inability to deal with them. 

Moody’s is the last of the big three ratings companies to give the government its highest credit rating, with Fitch having downgraded the U.S. to AA+ status earlier this year, and S&P having done so in 2011. In response, yields on 10-year Treasurys edged up a scant 2.7 basis points, while the dollar barely budged.

“I don't think really there's any major macroeconomic impact from this downgrade,” said Bernard Yaros, chief U.S. economist for Oxford Economics.

And if Moody’s were to actually go through with lowering its U.S. debt rating?

“It might lead to some intraday volatility, but I don't think it's really a regime shift for the long-term rates which would impact the economy,” Yaros said.

That’s a far cry from 2011 when news of S&P’s downgrade rattled markets, causing the S&P 500 stock index to drop 6.6% in one day. That downgrade had come as a surprise amid an unprecedented debt ceiling crisis in which Republicans in Congress were threatening not to pay the government’s debts. The Moody’s downgrade, if it comes, would be based on well-known and longstanding issues.

In its note warning of the potential downgrade, Moody’s explained the mounting U.S. national debt—$33 trillion and constantly growing—is becoming less affordable. Today’s high interest rates mean the U.S. is paying more to service that debt, making it less creditworthy. It’s a financial reality that the Congressional Budget Office has repeatedly noted.

“It's just reinforcing the drum that the CBO Congressional Budget Office has been beating for so long now,” Yaros said. “Barring any major change to taxes, entitlement, and our immigration system…we're not going to get our fiscal house in order.”

Still, even if the economic impact may be minimal, a downgrade would still be noteworthy.

“The Moody's move may be seen as a step toward catching up to the other rating agencies but if it did lose its last AAA rating that would be highly symbolic,” Jim Reid, chief U.S. economist at Deutsche Bank, wrote in a commentary this week.

And although the rating action could be less than seismic, the actual reasons behind it threaten the long-term outlook for the economy, Yaros said.

The Moody’s rating action comes amid more partisan clashes in Congress, with Republicans and Democrats facing off over next year’s budget and the possibility of a government shutdown looming. A bill passed by a bipartisan majority in the House of Representatives this week would fund the government through Jan. 19, delaying although not averting a showdown over spending priorities. Republicans have demanded steep spending cuts, including to social programs that Democrats would like to preserve.

While the current clash is likely to have a limited impact on the broader economy, Yaros said, it’s an example of the kind of government dysfunction that makes U.S. debt a little bit riskier in the eyes of market participants.

Not only that, but in Yaros’s analysis, even if the government were less divided in the future, neither Republicans nor Democrats are likely to prioritize reducing budget deficits. Democrats tend to favor higher spending, while Republicans want tax cuts—both of which increase deficits. That means paying for the national debt is likely to become financially problematic at some point, he said.

“Deficits do matter,” he said. “And at some point, we're going to get to a point where investors really lack the confidence that the government will pay them back, and then interest rates will spiral out of control, forcing the government to take some unprecedented action in terms of raising taxes or cutting spending.”

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  2. Congressional Budget Office. "The Budget and Economic Outlook: 2023 to 2033."

  3. Congress. "Further Continuing Appropriations and Other Extensions Act, 2024."

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