Last week, Moody’s, one of the world’s top credit rating agencies, downgraded US sovereign debt from AAA to AA1. While that’s just one notch on a 21-level scale, the implications could be wider than they first appear especially if you’re holding government bonds, considering gold, or looking for a safe haven in a turbulent market.

Why Does This Downgrade Matter?

Credit rating agencies like Moody’s, S&P and Fitch play an interesting role in global finance. Whilst they’re private firms unaffiliated with any government entity, their ratings have real influence, especially since institutional investors and pension funds often rely on these grades to guide what they can buy – in most cases, when an instrument is downgraded, the value of it falls and the opposite is also true.

So when Moody’s finally moved to downgrade US debt after S&P did it in 2011 and Fitch followed in 2023, it sent a signal. And unlike previous instances, this time around, US borrowing costs nudged higher almost immediately and in turn, increases in US inflation were felt.

So What’s Changed?

This downgrade didn’t come out of nowhere. In fact, the US federal deficit has been widening for years, and debt as a percentage of GDP has also rapidly increased over time. What’s got economists scratching their heads is that this fiscal deterioration has been happening despite a relatively strong economy.

In past cycles, deficits would typically expand during recessions or when unemployment surged. But this time, we’ve seen deficits widen even as the economy’s grown and job numbers looked decent. It’s a clear sign of underlying structural issues that can’t be blamed on COVID, lockdowns, or temporary stimulus packages (bounce back loans, furlough pay, etc) anymore.

Rising Interest Costs Are a Growing Concern

One of the less-discussed threats is the amount the US now spends servicing it’s own debt. When rates were low, between 2009 and 2022, the US could borrow freely without breaking the bank as most countries did, including the UK. But now that the Fed has pushed rates up, interest payments are starting to bite. And as borrowing continues, that cost is only going to continue to rise. What’s worse is that to service the debt, countries like the USA will either borrow more (at higher rates), increase tax (as we’ve seen in the UK under the leadership of the Labour party) or cut costs through austerity measures (which we saw during the 2010 by the Conservative and Liberal Democrat coalition government.

The Federal Reserve Economic Data (FRED) charts show a steep rise in interest expense relative to GDP since 2021. That’s a flashing red light for investors who remember what happened the last time interest outpaced growth.

If interest payments grow faster than GDP over the long term, you get:

  • Compounding deficits: More debt must be issued just to service existing debt.
  • Crowding out: Government borrowing can push up interest rates for businesses and consumers.
  • Credit downgrades: Like Moody’s and others have recently issued, eroding investor confidence.
  • Risk of stagflation or austerity: Governments may be forced to either inflate away debt or cut spending hard.

When interest outpaces growth, debt becomes unsustainable. It doesn’t explode overnight but it limits fiscal flexibility, raises borrowing costs, and eventually forces policy shifts and these shifts remain in place for several years. That’s why many gold investors see this environment as a long-term bullish signal for precious metals.

Policy Uncertainty and Investor Sentiment

Another factor adding fuel to the fire is political deadlock. As Congress debates the President’s latest budget, the proposals on the table don’t look like they’ll reduce the deficit any time soon. If anything, some plans are poised to grow it further. Combine that with mounting global tensions, and it’s no surprise investors are demanding higher yields to hold US government paper.

The current US budget proposals don’t look likely to reduce the deficit because they largely maintain or expand existing spending commitments without introducing meaningful new revenue streams. Much of federal expenditure is tied up in mandatory programmes like Social Security, Medicare, and debt interest—none of which are being cut. At the same time, there’s continued bipartisan support for high defence spending and industrial investments in areas like infrastructure, semiconductors, and green energy. Rather than making politically difficult choices like reforming entitlement programmes or raising taxes, proposals tend to preserve popular policies and push tough decisions further down the road.

In terms of government revenue, there’s no serious move to raise taxes or close major loopholes. In fact, some provisions from the 2017 tax cuts may be extended, further reducing income. Rising interest rates also mean that debt servicing costs are ballooning, consuming an ever-larger portion of the budget. Even optimistic economic growth assumptions aren’t enough to offset the structural imbalance. So while the economy remains strong and the dollar dominant, markets are beginning to price in the risk that deficits are no longer a temporary byproduct of crisis, but a permanent feature of US fiscal policy.

What This Means for Your Portfolio

I’m taking a cautious stance. The US is still a powerhouse economy, and the dollar isn’t losing its reserve status any time soon. But persistent deficits, rising interest burdens, and political gridlock mean risk is re-entering the equation.

Right now, the NASDAQ100 index has been falling for the last two days but with the downgrade and other pressures, it’s unsurprising that retail and institutional investors are becoming uncertain and redirecting their wealth towards other vehicles in response to their emotions.

In light of Moody’s downgrade, reducing exposure to alternative areas such as longer-dated US Treasures would be a fair response. Some investors may divert wealth towards shorter-dated bonds outside of the US invluding those denominated in euros and sterling to hedge against the risks posed by the US economy.

If you’re invested in US bonds or exposed to global markets, it may be worth rebalancing towards safer assets or diversifying into real assets like gold. With all this fiscal uncertainty, demand for tangible, non-yielding assets like physical gold and silver is likely to remain strong.

A Reason For Diversification

While this downgrade is just one move in what may be a drawn out series of events facing the US economy, it reinforces a view that government finances are becoming more of a headline issue for the US and beyond. Japan, for example, has seen bond yields continue to rise in recent weeks despite ongoing monetary easing; this is great news for investors but given Japan’s debt stands at 263% of GDP, according to Trading Economics, any increase in bond yields will significantly increase the interest payable on the debt.

The US environment calls for agility and diversification but keeping investment allocation conservative, scanning for new opportunities, and watching interest rates and inflation indicators closely is a wise decision. Now more than ever, staying ahead of the narrative matters.

If you’re sitting on longer-dated bonds or worried about portfolio exposure, reassessing your positions is a good idea, there may be better opportunities to be had elsewhere.