Beyond the 90-Day Tariff Pause

Why Emerging Markets May Outshine Debt-Laden Developed Economies

The biggest news of the week was Moody’s decision to downgrade the credit rating of the United States from Aaa to Aa1. The markets seem to be giving the move some degree of gravity, but it shouldn’t be considered surprising or unexpected. This downgrade simply matches what Fitch and S&P have already done and essentially reiterates what we already know about the U.S. fiscal situation.

The timing, however, can’t be ignored. The Moody’s downgrade comes right at the time when the White House is trying to push through a tax cut bill that’s likely only going to add to the federal debt and ensure the government keeps running trillion-plus dollar deficits for the foreseeable future. While this isn’t the only reason, it’s certainly a major contributing factor to why Treasury yields are moving higher right now. The 10-year yield has been moving steadily higher for nearly a month, while the 30-year bond just hit an 18-month high.

Overall, the bond market seems to be paying more attention to government fiscal issues. There’s little risk, obviously, that the U.S. government is going to default on its debt, but there’s an acknowledgement by the markets that the current path is unsustainable. Huge budget deficits were a feature during the COVID pandemic, but the fact that they’ve remained in place even throughout the post-pandemic recovery indicates that excessive government spending has become the norm, not the exception. If this tax cut bill passes, which it likely will eventually, Treasuries may have a harder time developing any momentum, save for a major economic downturn.

After Asian governments started dumping Treasuries post-Liberation Day, the credit downgrade and the impact of the tax cut bill are the latest wild cards that are preventing Treasuries from acting like a true risk-off asset. Gold, however, looks like it’s taking its place again. The price of gold in only a week has gone from $3145 to nearly $3300. The stockpiling of precious metals by global central banks has been going on for some time, but the sudden reversal in gold prices right around the time of the downgrade and the implications of the tax cut bill is probably not coincidental. Short-term sentiment may still be positive, but there appears to be a growing defensiveness building.