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On Wednesday, JPMorgan analysts provided insights on the implications of Moody’s recent downgrade of the United States sovereign credit rating from AAA. The analysts expect the direct impact on financial markets to be relatively modest, citing historical precedents and current market structures. This sentiment is reflected in the iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT), currently trading at $83.97, near its 52-week low of $84.83, with an average daily trading volume of 41.5 million shares. According to InvestingPro data, TLT maintains a solid financial health score of 2.71, rated as "GOOD" by analysts.
The downgrade follows previous cuts by S&P in 2011 and Fitch in 2023. Despite these downgrades, major bond index providers had already reclassified U.S. government-related bonds, such as Treasuries and Mortgage-Backed Securities (MBS), into the AA category after Fitch’s action in 2023. As a result, the downgrade by Moody’s, being the last of the three major rating agencies to do so, is unlikely to significantly alter the proportion of AAA-rated assets within the tradable global bond universe.
Analysts point out that bond index providers typically use the middle rating of the three major agencies or the strictest rating when categorizing bonds. Since the downgrade by Fitch in 2023, the share of AAA-rated bonds has stabilized at around 11%, a significant drop from the 40% prior to the downgrade. This shift mirrors a similar change in 2015 when S&P downgraded Japan, causing a reclassification from AA to A.
Regarding potential selling pressure from U.S. pension funds and insurance companies, which sometimes have AAA rating requirements for fixed income investments, analysts note flexibility within these policies. They highlight that entities like CalPERS do not necessarily have to sell downgraded securities immediately if no further credit risk is anticipated. European pension funds and insurance companies, holding approximately €400 billion in U.S. bonds, generally lack rating restrictions in their mandates, further dampening the likelihood of a sell-off due to the downgrade.
Additionally, the analysts mention that the downgrade is not expected to affect U.S. Treasuries’ eligibility as collateral in U.S. repo agreements. This is because regulatory frameworks such as Solvency II in Europe treat all government bonds as a single asset class, applying the same capital charges irrespective of the credit rating. This regulatory perspective reduces the potential impact that the downgrade might have on the liquidity or the demand for U.S. government bonds in financial transactions. InvestingPro data shows TLT’s strong liquidity position with a current ratio of 2.77, while maintaining a moderate beta of 0.49, indicating lower volatility compared to the broader market. Discover more exclusive insights and 6 additional ProTips with an InvestingPro subscription.
In other recent news, Citi’s analysis suggests that the recent downgrade of US assets is unlikely to significantly impact foreign demand for US Treasuries, even though the fiscal landscape in the US is becoming more challenging. The strategist highlighted that foreign investors purchased approximately $138 billion in long-term US Treasuries in March, showing continued strong demand. Meanwhile, Federal Reserve Vice Chair Philip Jefferson discussed the importance of central banks providing liquidity during financial stress at the 2025 Financial Markets Conference. He emphasized the role of intraday and overnight credit facilities in supporting the smooth functioning of the payment system.
Furthermore, Federal Reserve officials, including Chair Jerome Powell, are reconsidering their monetary policy approach due to recent inflation experiences and potential future supply shocks. Powell noted the need to reassess strategies adopted in 2020, particularly in light of changing economic conditions. Federal Reserve Governor Adriana Kugler also commented on the challenges of assessing the economy’s strength amid shifting trade policies, which have clouded predictions for growth and inflation. JPMorgan analysts provided insights into economic data trends, noting a divergence between resilient ’hard’ data and potentially weak ’soft’ data, with concerns over labor market health and rising inflation expectations. They suggest that international equities may outperform US equities, given the current market volatility and trade uncertainties.
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