The Fiscal Context for the Moody’s Downgrade of Uncle Sam

 (This post dovetails with Murphy’s analysis in InFi ep. 91.)

On May 16, Moody’s announced that it was downgrading unsecured US Treasury debt to its second-highest notch of Aa1. For historical context, Moody’s originally gave Uncle Sam its highest rating of Aaa way back in 1919. The other two major ratings agencies, namely Standard and Poor’s and Fitch, had likewise downgraded US Treasury debt to their second-highest notches (in 2011 and 2023, respectively).

As Moody’s official announcement explains:

This one-notch downgrade on our 21-notch rating scale reflects the increase over more than a decade in government debt and interest payment ratios to levels that are significantly higher than similarly rated sovereigns.

Successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs. We do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration. Over the next decade, we expect larger deficits as entitlement spending rises while government revenue remains broadly flat. In turn, persistent, large fiscal deficits will drive the government's debt and interest burden higher. The US' fiscal performance is likely to deteriorate relative to its own past and compared to other highly-rated sovereigns. 

In this post I just want to highlight two items from the Congressional Budget Office (CBO)’s latest long-term economic outlook, released in March of 2025. The first diagrams show the debt and deficit projections as a share of GDP:

As the figures show, the US debt (relative to the economy) is currently about tied with its all-time record set during World War 2. But back then, after the one-off emergency, federal spending drastically fell and the US outgrew its debt burden. In other words, the economy grew faster than the stock of debt during the 1950s and ’60s, which is why the debt-to-GDP ratio plummeted in the postwar era.

We have nothing analogous this time around. Even though spending jumped in the wake of the 2008 crisis and Covid, the future increase in federal debt is driven by built-in entitlement spending, as well as increased interest expense on the debt.

Furthermore, the collapse in federal finances isn’t because of projected spikes in interest rates due to a strike in the bond markets. As the following table shows, the CBO projections are merely assuming a return of interest rates to historical averages: 

Specifically, even through 2055, the CBO projections assume the average interest rate on federal debt will be 3.6 percent, whereas the average for 1995-2024 was 3.8 percent. What happened is that interest rates (particularly on Treasury debt) dropped to ludicrously low levels in the wake of the 2008 crisis, such that the mountains of new debt that the feds accumulated didn’t feel so painful for current operations.

Conclusion

Although some cynics attributed the timing of the Moody’s downgrade to politics—after all, the long-term fiscal outlook was pretty grim during Biden’s last year too—there can be no doubt that their concerns are justified. Reasonable forecasts shows rising debt as far as the eye can see, and that doesn’t include the possibility of another economic crash or a sudden spike in interest rates if bondholders get spooked.

These facts are all the more reason that households and institutions should diversify their portfolios to ensure they can withstand a drop in the USD and/or Treasuries. Here at infineo, we’re doing our part to make blockchain-based finance easier and inclusive of more asset classes.

Dr. Robert P. Murphy is the Chief Economist at infineo, bridging together Whole Life insurance policies and digital blockchain-based issuance.

Twitter: @infineogroup, @BobMurphyEcon

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