What happened

Last shoe to drop. Over the weekend, Moody’s – the credit ratings agency – downgraded the credit ratings of US debt from Aaa to Aa1. With this move, the “holy trinity” of ratings agencies - Moody’s, S&P and Fitch - are finally in agreement on the creditworthiness of (ironically) the world’s risk-free rate, long after S&P had first downgraded US debt on 5 August 2011 and Fitch on 1 August 2023. In its decision, Moody's noted that successive US administrations had failed to reverse ballooning deficits and interest costs, a significant pivot given that it has given a perfect credit rating for the US since 1917.

What it means

This is certainly not new to the markets, given that we have had a foretaste of US debt downgrades with S&P and Fitch. Clearly, a downgrade from AAA to AA+ does not signify imminent default risk, but it does continue to signal concerns over US fiscal management and political dysfunction. At the margin, credit funds that have mandate requirements of “best of” or “average of” ratings at AAA would have to make portfolio adjustments or provisions to accommodate this rating change – which also influences the ratings of other state and municipal bonds, as well as MBS. Other considerations include:

• Higher borrowing costs. With most other currencies, a debt downgrade is often followed by higher domestic rates as investors demand a risk premium for holding the countries’ bonds. With the dollar still being the reserve currency of the world, this mechanism would apply to a smaller degree, although we think US curves will steepen as the long-term outlook for the US fiscal trajectory is deteriorated. Note, however, that US treasuries conversely saw lower yields after S&P first downgraded US debt due to uncertainty driving flight-to-safety flows.
• Volatility. This generation of investors have been taught that the US treasury rate is the risk-free rate by which all other assets – including equities, credit, options and other derivatives are priced. Uncertainty about this benchmark role of US treasuries would inevitably lead to uncertainty everywhere else.
• Reserve considerations. In an environment where the reserve quality of US treasuries is already called into question, its credit downgrade only adds fuel to the fire, which would compel ex-US sovereign wealth funds, pensions, and other asset managers to diversify into other alternatives.
• Reduced fiscal space. Higher debt servicing costs and concerns of fiscal management would reduce the policy flexibility of congress. This could bring additional headwinds to President Trump’s 'big, beautiful' tax bill, which had already met with roadblocks last Friday as several Republican lawmakers voted against it.

How to invest

Equities

Moody’s downgrade on US credit rating has sent US equity-futures lower. But history suggests that such knee-jerk reactions are typically short-lived given the largely symbolic nature of Moody’s downgrade. Previous downgrades by S&P in 2011 and Fitch in 2023 saw the S&P 500 posting losses of 8.3% and 10% respectively. But the market eventually returned to its previous peak within 10 days and 122 days respectively. We advocate investors to look beyond the near-term volatility and maintain a positive view on equities segments underpinned by structural shifts, for instance:

• US Technology: Investment in AI continues to be robust; Microsoft, Amazon, and Google plan to invest a combined USD250bn in 2025 on AI infrastructure, data centres, chip procurement, and next-gen algorithms to drive ecosystem growth. Similarly, the Middle East is stepping up its efforts to ensure it is not being left behind in the AI revolution, with an estimated USD100bn in AI-driven technology investments over the remainder of the decade.
• Europe Equities: We are 3-month Overweight on Europe in anticipation of fiscal tailwinds in the coming years. Germany recently approved a EUR500bn infrastructure fund that aims to modernise key areas like transport, energy, and digitalisation, which will drive economic growth. This move has also prompted discussion within the EU about loosening fiscal constraints, signalling a shift from its traditionally cautious fiscal stance
• Asia ex-Japan Equities: The downgrade is unlikely to weigh too adversely on Asia ex-Japan (AxJ) markets but could serve as a catalyst for renewed inflows. With AxJ equities still largely under-owned, investors may view the region as a relatively attractive alternative. Supported by healthier sovereign balance sheets, the China government’s push for domestic consumption, and valuation discounts, AxJ offers both diversification and growth potential.

Bonds

• The constant echo of US indebtedness once again portends steeper yield curves. We maintain that ultra-long duration bonds (>10Y) are not a suitable play for this environment and continue to favour a barbell duration expression of 2-3Y and 7-10Y bonds. Investors can take advantage of rate swings to add IG credit to the 7-10Y bucket when 10Y UST yields exceed 4.5%.
• High quality credit would be a bastion of stability amid uncertainty, as spreads provide a cushion to rates volatility. Stay with A/BBB bonds as a preferred ratings segment and be selective on HY credit in the BB segment.

Gold

• This development is gold positive as the precious metal is seen as a hedge against monetary excesses and is positively correlated with US indebtedness.
• Alongside other tailwinds such as geopolitical uncertainty and rising recession/stagflation risk in the US, the case for holding gold as a multi-directional hedge remains stronger than ever.

Stay invested. We encourage investors to stay invested as (a) the deteriorating credit trajectory of the US government is a known risk, and (b) Moody’s is only marking its ratings and rationale to what was already known with S&P and Fitch. As the volatility in trade uncertainties post Trump’s “liberation day” would show us, investors are better off not timing markets, but utilising the volatility to add to quality positions in a balanced, well-diversified portfolio.