NEW YORK, May 19 (Reuters) - U.S. Federal Reserve officials speaking on Monday took on cautiously the ramifications of the latest downgrade of the U.S. government’s credit rating and unsettled market conditions as they continued to navigate a very uncertain economic environment.
"We will put that downgrade in the same perspective that we do with all incoming information: What are the implications of this in terms of us achieving our mandated goals without commenting on what that downgrade might mean in sort of a political economy context," Fed Vice Chair Philip Jefferson said at a conference held by the Federal Reserve Bank of Atlanta.
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On Friday, Moody’s ratings agency lowered the U.S. government’s credit rating one notch amid mounting concerns over deficits and interest costs that remain on an unsustainable pace. It was the last of the major ratings agencies to cut the U.S. sovereign rating from the highest level.
While not an imminent issue for the Fed, over time higher market borrowing costs tied to a deteriorating U.S. financial position make credit generally more expensive and create restraint on economic activity. In turn that becomes a consideration for how the Fed sets monetary policy and its expectations for the longer-run path of economic activity.
The downgrade "will have implications for the cost of capital and a bunch of other things, and so it could have a ripple through the economy," said Atlanta Fed President Raphael Bostic, speaking in a CNBC interview on Monday. With the economy in flux, "I think we'll have to wait three to six months to start to see where this settles out, and I think that'll be an important determinant about people's willingness and appetite for investing in the U.S."
While concerns about the government’s financial position have existed for years, and Fed officials have regularly warned that long-run borrowing trends have been on an unsustainable path, ongoing huge levels of spending, joined with a Republican budget plan now under consideration that’s likely to add even more debt, are raising fears of a nearing crisis.
At the same time, the aggressive and erratic trade policy agenda of the Trump administration, which targets most of the world’s nations with high tariffs in a bid to bring more factory work back to the U.S., is shaking confidence in the U.S. as a reliable place to invest.
On Monday, stock markets were selling off as bond yields rose. President Donald Trump said he disagreed with the action taken by the ratings agency.
U.S. STILL ATTRACTIVE
Speaking at a conference held by the Mortgage Bankers Association in New York, New York Fed President John Williams acknowledged market issues but suggested some of the concerns are overblown.
"We have heard over the last few months, there are some rumors or concerns about, well, do investors want to be so heavily invested” in Treasuries and other dollar assets given big government policy changes and large levels of economic uncertainty, Williams said.
Investors are “clearly” weighing future options, he said. Nevertheless, investors "have viewed and continue to view" the U.S. as "a great place to invest, including Treasuries, fixed income assets, so I think that that narrative is still there."
In a hometown appearance, Minneapolis Fed President Neel Kashkari said that over the long run, retaining investor confidence is one of the key issues that will determine whether government borrowing rates remain manageable.
"Right now there's a question mark being raised about what is the U.S. competitive position going to be relative to other advanced economies around the world," given all of the policy changes and debt issues, Kashkari said.
"There's more of a question mark than there was a year ago or two years ago," he said, adding "we don't know right now" how this will all shake out.
Concern over the future of official finances is particularly pointed given the U.S. government bond market’s traditional role as a global safe haven for investors. That role is being challenged by the possibility markets will no longer be able to smoothly absorb the huge supply of Treasury debt, as trade policy could work to deter investors and upend the flow of dollars back into U.S. markets.
“The sell-America theme in today’s trading with U.S. bonds, stocks and the dollar all pointing sharply lower on Moody’s U.S. rating downgrade suggests this is serving as a coordinating device for an underlying shift in global investor preferences coming out of Trump tariff and wider geoeconomic shocks that is still in process,” said analysts at Evercore ISI.
In this current climate of large-scale uncertainty and anxiety, “the fact that U.S. Treasuries and the dollar are not rallying now is striking and shaves away a fraction of the attractiveness of Treasuries going forward.”
The impact of the Moody’s ratings change remains a work in progress and some see little lasting impact. Barclays analysts told clients on Monday “we expect few consequences from the Moody's downgrade.”
The Fed officials who spoke Monday also continued to send a wait-and-see signal on the outlook for monetary policy.
Williams said the economy is in a good place with interest rate policy “well positioned” to respond to what lies ahead. Meanwhile, Bostic said with his current expectations it will now take longer to lower inflation back to 2%, "I am leaning much more into one cut this year.”
Reporting by Michael S. Derby; Editing by Andrew Cawthorne, Paul Simao and Andrea Ricci
