Everyone is talking about the Moody’s downgrade and there are of course the usual doomsday-like opinions spreading. In my opinion, this is no big deal. It’s more of a symbolic thing. The S&P Global Ratings downgraded the US in 2011 and Fitch did so in 2023. Why should we care now about Moody’s downgrade?
Some say that the context is different because of the deficits and the recent trade war, and I can get behind that idea, but the biggest drivers of advanced economies long term yields is future central bank policy and inflation expectations. As you can see from the chart below, long term Treasury yields have been ranging between 4% and 5% mainly because of pro-growth fiscal policies and the Fed keeping rates higher for longer.
If the Fed were to hike now and trigger a recession, the long term yields would drop below 4% pretty quickly and nobody would care about the Moody’s downgrade. In fact, as we now price in better and better conditions for growth, the economic activity will
likely start to accelerate and that could lead to inflationary pressures. Now, one can trash the UMich survey for the political bias and so on, but the Fed hasn’t met the target for almost 5 years and at some point the time factor could pose a risk for a de-anchoring of inflation expectations, so one cannot dismiss it. Better to be open-minded
