Moody’s decision to downgrade the U.S. credit rating from its top “Aaa” to “Aa1” wasn’t a huge surprise, given the growing deficits and rising interest costs. Still, it did put some pressure on markets: U.S. Treasury yields went up on Monday morning, while futures for the Dow Jones, S&P 500, Russell 2000, and Nasdaq all opened lower, along with the U.S. dollar index.
Naturally, this brought back comparisons to past downgrades, especially 2011, when S&P Global cut the U.S. credit rating over concerns that Congress's and the White House's deficit-reduction plan wasn’t enough to rein in rising debt over the medium term. The next day, the S&P 500 and Nasdaq dropped about 6%. It was not a catastrophe, but it was definitely unpleasant.
But it's worth remembering that when Fitch did the same thing in 2023, the market response was mostly muted. There were some short-lived equity market fluctuations, but no significant long-term effects. This time, a similar pattern could be repeated, especially if Trump delivers optimistic headlines about trade negotiations, such as those with Europe or Japan.
Of course, sentiment could also take a hit, but that would require a major change in the economic outlook. For now, though, U.S. Treasury Secretary Bessent has promised that the administration will ensure GDP growth outpaces debt growth, stabilizing the debt-to-GDP ratio. Meanwhile, Barclays has upgraded its GDP growth forecast and no longer expects a recession.
Turning to the current situation, the University of Michigan reports that preliminary consumer confidence in May fell to 50.8, down from 52.2 in April and below expectations. In April, retail sales rose only 0.1% month-over-month, while industrial production posted no growth, up only 1.5% year-over-year. Even manufacturing production recorded a slight decline.
As for inflation, the annual rate slowed down in April, with a month-on-month increase of only 0.2%. Prices were up 2.3% from a year earlier, slightly down from 2.4% in March. But there's a catch: tariffs remain well above pre-Trump levels, which could add renewed upward pressure on prices in the coming months. If so, the Fed will wait to lower interest rates.
Overall, while the rhetoric remains reassuring, the data show clear signs of a slowdown, paired with rising inflation expectations. However, markets are not usually based on the present or even the past but on the future. And if there is hope that the outlook may improve, optimism tends to return. This seems to be the scenario that investors are betting on.