Why are stocks pushing higher after Moody's US credit rating downgrade

Major US benchmarks showed resilience overnight, with traders largely dismissing Moody’s Ratings downgrade of the US credit rating over the weekend. The S&P 500 gained 0.09%, clawing back early losses of 1.05%, to extend its winning streak to six sessions. The index has now rallied 23% from its April 7 low and is up 1.6% year-to-date.

Safe-haven and risk-sensitive assets, such as bonds, the VIX, and gold, saw brief spikes but quickly retreated from their session highs.

The S&P/ASX 200 is also trading broadly higher on Tuesday, up 0.8% after a 0.5% fall in the previous session.

Moody's downgrade

To recap, Moody’s Ratings downgraded the US credit rating from AAA to Aa1, citing rising debt levels, wider fiscal deficits, and higher interest payments.

The agency highlighted a decade-long increase in government debt and interest payment ratios, now significantly higher than those of similarly rated sovereigns.

Moody’s noted that “successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs,” projecting deficits to expand from 6.4% to nearly 9% of GDP by 2035.

This isn't the first time the US's pristine 'AAA' rating has been cut. Moody's is the last of the three major credit agencies (S&P and Fitch) to downgrade it.

Previous downgrades

S&P first downgraded the US from AAA to AA+ on 5 August, 2011. This was the first time the US lost its perfect credit rating from a major agency, triggered by a contentious debt ceiling crisis. The agency said "political risks" and "America's governance and policymaking [have become] less stable, less effective, and less predictable."

The downgrade sparked fears that Treasuries, no longer AAA-rated, would face forced selling due to restrictions in derivative products, loan agreements, and investment mandates.

The S&P 500 plummeted 6.7%, and the VIX surged to 45, reflecting widespread market panic that persisted for a week.

Fitch downgraded the US from AAA to AA+ on 1 August, 2023, pointing to fiscal deterioration, a growing debt burden, and governance erosion driven by “repeated debt-limit political standoffs and last-minute resolutions.”

The S&P 500 fell 1.4%, and the US 10-year Treasury yield jumped to 4.1% the next day, the highest since November 2022. Markets remained under pressure for the week.

Post-downgrade performance

While both prior downgrades triggered short-term market declines (1-3 months), the S&P 500 stabilised and delivered strong medium-term returns.

On average, the index gained 19.8% in the 12 months following the S&P and Fitch downgrades, according to Carson Investment Research.

Source: Carson Investment Research

Source: Carson Investment Research

The bottom line

One could argue that Moody’s downgrade technically doesn’t change the US’s current AA+ rating, as S&P and Fitch have already assigned this rating. Its now a unanimous AA+.

Morgan Stanley’s Michael Wilson sees the downgrade as a buying opportunity, citing recent US-China trade de-escalation as reducing recession risks. However, he cautioned that rising bond yields could pressure equities if the US 10-year yield breaches 4.5%. “We would be buyers of such a dip,” Wilson noted.

Wilson also highlighted a resilient corporate earnings season, unaffected by tariff uncertainties, and a pickup in profit upgrades, signaling potential for further equity gains despite possible near-term trade data weakness.

While Moody’s downgrade may spark short-term market volatility due to its symbolic weight, it’s likely to fade from memory within weeks, with minimal lasting impact.