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On Friday, Moody’s pulled the trigger and stripped the US of its last top rating — downgrading it one notch from Aaa to Aa1.
But does it matter?
We looked into the implications of a downgrade a couple of months ago, back when Moody’s still seemed determined to ignore the sixty-foot flashing neon signage writing on the wall.
From a stock market perspective, who knows? We have no clue whether, or how much, it will matter when trading opens on Monday. Sure, S&P’s US sovereign downgrade in August 2011 prompted the worst single day fall in US stock prices since the (admittedly then recent) global financial crisis. But the market quickly recovered. This may have been people freaked out about what the downgrade might mean to the financial plumbing.
So, does the downgrade matter to financial plumbers this time? From a mechanical perspective, the answer is almost certainly “not at all”.
Banks’ risk-weighted capital asset calculations look unlikely to be impacted by the rating change. This is because regulators don’t tend to differentiate between Aaa and Aa1 when setting capital risk-weights. For example, this is how the BIS sets out its standardised approach for credit risk as it applies to individual claims to calculate their risk-weighted assets in relation to sovereigns:
Moody’s could’ve done a three-notch downgrade — from Aaa all the way to Aa3 — and nothing would’ve changed on this front.
How about collateral management? A note from Barclays on Friday night looked at the implications:
For collateral purposes, a downgrade to Aa1 is also unlikely to have an effect. For instance, DTCC and CME refer to the asset class as US Treasuries and the haircut is a function of the maturity and security type (TIPS/FRNs) but not the ratings. At LCH, a downgrade to Aa1 is unlikely to lead to a change. For instance, USTs and Gilts have similar haircuts, even as the latter are rated lower.
Furthermore, they reckon that the move won’t trigger moves at the short end of the curve because:
Legislation since the financial crisis has reduced the use of explicit ratings guidelines in investment mandates.
So, they don’t expect waves of asset sales from the circa $4.5tn in Treasury and Treasury repo in money funds.
Moving away from financial markets, the downgrade may well matter to Moody’s themselves. If S&P Global Ratings’ experience in 2011 is anything to go by, the firm will be in for a rough ride. Following S&P’s downgrade more than a decade ago, US Treasury Secretary Tim Geithner threw a bit of a public wobbly, and filmmaker Michael Moore called on Obama to arrest the firm’s CEO. As we wrote in March:
Someone hired a plane to fly past their rating agency’s offices dragging a banner proclaiming that they should all be fired, and a bunch of local governments terminated their business with the firm.
Meanwhile, and apparently unrelatedly, the Justice Department launched an investigation into S&P. Within a few weeks, CEO Deven Sharma had left the company. When things moved from being just an investigation to an actual $5bn federal lawsuit for allegedly misleading banks about the credibility of its ratings before the 2008 financial crisis, S&P called this direct retaliation for its downgrade.
Following the downgrade, Moritz Kraemer — formerly Global Chief Rating Officer of Sovereign Ratings at S&P Global Ratings — wrote on LinkedIn that the danger of retribution was real:
In the US, the rating agencies are regulated and licensed by the SEC (Securities and Exchange Commission). As things stand in America today, we must wonder, whether the SEC can act independently from the wishes of the White House. Remember that the previous SEC chairman, Gary Gensler, resigned on inauguration day, making way for a Trump acolyte. Will Trump be so enraged by the downgrade of the US (which he surely will take personal) that he will demand his pound of flesh and impose revenge on Moody’s.
We’ve already seen the White House dismiss the analysis, and lash out at Mark Zandi, Moody’s chief economist. Steven Cheung, assistant to the President, tweeted: “Nobody takes his ‘analysis’ seriously. He has been proven wrong time and time again.”
As reported in MainFT, Zandi was not an author of this report and works for Moody’s Analytics, a separate part of the company that is not part of its ratings business.
More generally, while a one-notch downgrade from Aaa may not have huge market implications it is still important.
Fiscally, Moody’s has long projected near-basket-case metrics for the United States. In reaffirming the Aaa rating back in March it wrote that the country’s Aaa rating leaned instead on the country’s “extraordinary economic strength and the unique and central roles of the dollar and Treasury bond market in global finance”.
And in its previous rating report reaffirming the Aaa rating back in November 2023, Moody’s wrote:
A weakening of institutions and governance strength, such as through deterioration in monetary and macroeconomic policy effectiveness or the quality of legislative and judicial institutions, could also strain the rating.
The world has moved on since 2023, and Moody’s is marking-to-market.
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