Moody Blue
US
USD is under downside pressure with 10-year Treasury yields extending gains above 4.51% and US equity futures down over 1%. On Friday, Moody's Ratings downgraded US government debt one notch to Aa1 from AAA citing the large fiscal deficits and rising interest costs. Indeed, the Congressional Budget Office (CBO) projects the federal debt to balloon from currently 98% of GDP to a record high of 155% of GDP in 2055.
The Moody’s downgrade aligns it with Fitch Ratings and S&P Global Ratings, which lowered US debt one notch from a perfect AAA rating in 2023 and 2011, respectively. The market reaction to the S&P downgrade on August 5, 2011 was significant. On August 8, 2011, the first trading day after the downgrade, the S&P500 plunged about 6.7% while Treasury yields paradoxically fell on safe haven demand and USD ticked-up.
The market reaction to Fitch Ratings’ downgrade on August 1, 2023 was more muted. One reason is that post-2011, most institutional investors had shifted away from requiring only AAA-rated debt in their investment mandate. As such, we expect the ripple effect on financial markets of Moody's Ratings downgrade to also be contained.
In fact, investors remain largely unfazed by the chronic US fiscal imbalance. Foreign holdings of US Treasuries surged to an all-time high of $7.63 trillion in March and the compensation investors require for holding long-dated Treasuries (the term premium) remains relatively low .
Nonetheless, US trade policy uncertainty, doubts about the rule of law, escalating fiscal burden, and interference with the Fed’s independence threaten to make the US a less attractive place to invest. The synchronized selling of USD, Treasuries and US stocks highlight the growing loss of confidence in the US economy. USD is vulnerable to more downside this week.
Yesterday, the House Budget Committee approved President Donald Trump's “One Big Beautiful” tax and spending package. A vote by the entire House of Representatives is anticipated before Memorial Day (May 26). If passed by the House, the bill moves to the Senate. The nonpartisan Tax Foundation estimates the House bill would add $3 trillion to $4 trillion to the nation's debt over the next decade while the Committee for a Responsible Federal Budget says the cost could be as high as $5.3 trillion.
Fed speakers today: Atlanta Fed President Raphael Bostic (non-voter), Fed Vice Chair Philip Jefferson, New York Fed President John Williams, Dallas Fed President Lorie Logan (2026 voter), and Minneapolis Fed President Neel Kashkari (2026 voter).
EUROZONE & UK
EUR/GBP is heavy near important technical support at 0.8400. The UK-EU summit takes place today. This is the first leader level post-Brexit summit and is expected to focus on defense and resetting post-Brexit relations. Closer UK-EU trade relations can lead to a more favorable UK business investment outlook, which bodes well for GBP.
EUR/USD is firm around 1.1200. ECB President Christine Lagarde pointed out over the weekend that the recent strength in the euro against the dollar “is counter-intuitive but can be explained by the level of uncertainty and the fact that some parts of the financial markets are losing confidence in US policies.” We agree. Additionally, the move towards deeper European Union integration is another factor underpinning EUR strength.
CHINA
USD/CNH is firmer but holding under its 200-day moving average at 7.2235. China’s April real sector data was soft. Industrial production rose 6.1% y/y (consensus: 5.7%) vs. 7.7% in March. Retail sales grew 5.1% y/y (consensus: 5.8%) vs. 5.9% in March and fixed-asset investment eased 4.0% YTD (consensus: 4.2%) vs. 4.2% in March. More policy easing and fiscal reforms that lead households to gain a greater piece of the economic pie are necessary to support growth.
