(Bloomberg) -- The fiscal strength of the United States is stuck in a multi-year slide and "has deteriorated further" after the country's sovereign rating received a negative outlook in late 2023, Moody's Ratings said.
"Higher interest rates have markedly weakened debt affordability, accelerating the decline in fiscal strength," analysts led by William Foster wrote in a report published Tuesday. The company said debt affordability is "the most important determinant of our assessment of US fiscal strength," and that is derived from the metrics of interest payments-to-revenue and interest payments-to-GDP.
A sharp and sustained rise in US Treasury yields from very low levels in 2020, has resulted in diminished debt affordability, and Moody's forecasts a rising pace of deterioration due to interest payments-to-revenue increasing to about 30% by 2035 from 9% in 2021. "At these levels, fiscal flexibility is considerably reduced," it said.
Moody's explained that a weakening US debt affordability profile means the country's "extraordinary economic strength and the unique and central roles of the dollar and Treasury bond market in global finance are even more critical in supporting the sovereign's Aaa credit profile."
Still, Moody's warned "the potential negative credit impact of sustained high tariffs, unfunded tax cuts and significant tail risks to the economy," could result in the US strengths of being the key player in global finance proving less effective in countering "widening fiscal deficits and declining debt affordability."
The nonpartisan Congressional Budget Office is set to release new estimates Thursday on the government's long-term economic and budget outlook.
The report said even the most optimistic scenario where the US economy experiences "sustained 3% real GDP growth, a terminal 10-year Treasury yield of 3% and significant cuts to government spending," would only stabilize debt affordability "at weaker levels than in 2023 and remains materially weaker than for other Aaa-rated sovereigns."
In November 2023, Moody's lowered the US sovereign outlook to negative from stable while affirming the nation's rating at Aaa, the highest investment-grade notch.
In September of last year, Moody's warned the next US administration "must grapple with widening budget deficits," and noted that elevated Treasury yields above 4% would challenge servicing the cost of US debt.
Moody's is the only one of the three main credit companies with a top rating on the US after Fitch Ratings downgraded the US government in August 2023 after another debt-ceiling battle in Congress. S&P Global Ratings stripped the US of its top score in 2011 amid that year's debt-limit crisis.
Further report highlights:
- Moody's expect the "federal government's fiscal deficit will widen to about 8.5% of GDP by 2035 from around 6.3% in 2025," due to increased interest payments and health-related entitlement costs.
- The debt burden is projected to "rise to around 130% of GDP by 2035 from nearly 100% in 2025."
- The US debt burden was about 109% of GDP in 2024 relative to a much lower median ratio of about 43% for Aaa-rated sovereigns."
- They expect the 10-year Treasury yield to peak at an average of around 4.4% in 2025 and gradually decline thereafter to settle at a terminal yield of 4% by 2029.
- A decline to 3% in Treasury yields is deemed, "very unlikely in the near term absent a major economic shock that results in de-risking of global financial markets."
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