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Markets opened the week by reacting to Friday’s credit rating downgrade of U.S. sovereign debt by Moody’s, one of the three largest credit rating agencies. Long-term Treasury yields rose Monday morning on the news, sending the price of the iShares 20+ Year Treasury Bond ETF (TLT), the $49 billion long-duration bond proxy, 0.6% lower.
Because bond prices and yields move in opposite directions, the decline in TLT reflected investors demanding higher returns to hold U.S. debt in light of the downgrade from Aaa to Aa1.
On the equity side, the SPDR S&P 500 ETF Trust (SPY) opened more than 1% lower to start Monday’s trading but steadily recovered and moved into positive territory by early afternoon.
The muted stock market reaction suggests equity investors view the downgrade as largely symbolic, acknowledging an already well-known U.S. fiscal picture that is likely priced into the market.
The Moody’s downgrade official news release stated, “This one-notch downgrade on our 21-notch rating scale reflects the increase over more than a decade in government debt and interest payment ratios to levels that are significantly higher than similarly rated sovereigns.”
Rating Downgrade Impact: Stocks vs. Bonds
A credit rating downgrade has a direct impact on fixed-income markets because it can increase borrowing costs and affect the perception of credit risk for sovereign debt. Moody’s cited concerns about America’s growing fiscal deficits and political polarization as reasons for its shift in outlook.
Bond investors are sensitive to these changes because credit ratings influence risk assessments, capital requirements and institutional mandates. A lower rating can lead to higher yields as investors demand more compensation for perceived risk, thereby reducing bond prices.
Conversely, the stock market often reacts less dramatically, especially when such changes reflect long-standing issues already known to market participants.
Looking Back: 2011 and 2023 Downgrades
The market reaction to prior U.S. credit downgrades offers useful context. In 2011, Standard & Poor's downgraded the U.S. from AAA to AA+ during the Obama administration amid a debt ceiling standoff while the U.S. economy was still recovering from the 2008 financial crisis.
That event triggered a sharp short-term selloff in equities and volatility across asset classes. However, stocks soon rebounded and resumed their upward trend.
More recently, Fitch downgraded the U.S. credit rating in August 2023, again citing concerns over fiscal deterioration and governance issues. The initial market reaction was modest: Equities dipped temporarily while Treasury yields ticked higher.