Investing.com - Several potential storm clouds are on the horizon for U.S. Treasuries following Moody’s decision to lower its U.S. credit rating, according to analysts at Capital Economics.
Moody’s cut its rating of U.S. credit by one tick to "Aa1" from "Aaa" on Friday, noting that debt and interest in the U.S. are "significantly higher than similarly rated sovereigns". The U.S. currently faces a $36.22 trillion debt pile, according to the Treasury Department.
In a note to clients, the analysts led by Thomas Mathews argued that, following similar ratings downgrades in the past, investors have largely been able to brush off the impact of these moves on Treasuries because of the supposed safe-haven status of U.S. government debt.
"But sentiment around that status has arguably deteriorated a bit of late, and the Moody’s downgrade comes at a slightly more fragile time for the U.S. bond market," the analysts wrote.
Several fresh risks now stand before U.S. Treasuries, they added, including the prospect of additional growth in U.S. obligations.
The House of Representatives may vote later this week on U.S. President Donald Trump’s sweeping budget bill, which nonpartisan analysts have said could add $3 trillion to $5 trillion to the national debt over the next decade.
Moody’s flagged last week that "successive U.S. administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs".
Meanwhile, Trump has reiterated in recent days his challenges to the independence of the Federal Reserve as part of his bid to pressure officials into slashing interest rates, although he appears to have backed off from threats to oust the central bank’s Chair Jerome Powell, the Capital Economics analysts said.
Any sign of a Fed cutting "at the whim" of the Trump administration "could be further bad news" for long-dated Treasuries, they added.
Trump’s ongoing, albeit potentially easing, aggressive trade policy has also put weaker currencies and massive current account surpluses in Asia "under fire", the strategists said. These two trends have underpinned substantial Treasury holdings in the region, and any changes towards these policies could lead to a reduction in demand for dollar assets such as Treasuries, they said.
"Our ’base case’ remains that investors’ nerves will hold, the debt situation will remain tough but manageable, and as such the 10-year Treasury yield won’t rise on net between now and the end of this year," the analysts said.
"But it seems, to us that it’s becoming easier to build a more-negative case for the fortunes of the world’s largest bond market."