Moody’s Downgrades U.S. Credit Rating, Widening Economic Divide

Moody’s Downgrade and Its Implications

On Friday, Moody’s Investors Service lowered the U.S. government’s credit rating from Aaa to Aa1. This change marks the last major downgrade, following S&P’s initial action in 2011 and Fitch’s rating change after the 2023 debt ceiling debate.

Moody’s provided this rationale:

We do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration.

Over the next decade, we expect larger deficits as entitlement spending rises while government revenue remains broadly flat. In turn, persistent, large fiscal deficits will drive the government’s debt and interest burden higher.

The U.S. fiscal performance is likely to deteriorate relative to its own past and compared to other highly-rated sovereigns.

The Impact on Treasuries Market

In response, Treasury Secretary Scott Bessent sought to mitigate concerns, stating:

I think that Moody’s is a lagging indicator. I think that’s what everyone thinks of credit agencies.

Despite his assurances, bond yields surged soon after the announcement. Higher yields often arise from increased perceived risk, leading investors to demand larger returns.

Typically, elevated bond yields pose challenges for both Wall Street and Main Street by increasing borrowing costs. Notably, the yield on the 10-year Treasury rose to 4.56%, with the 30-day Treasury reaching 5.03%, its highest this year.

Investor Louis Navellier, however, is not overly concerned about the impact on treasuries. He noted:

The treasury auctions are going much better under Scott Bessent than they were under Janet Yellen.

Growing Wealth Gap in Housing Market

The National Association of Realtors (NAR) highlighted the widening wealth gap in a recent report. Key findings indicated:

Higher-income households have near-total access to the housing market. Homebuyers earning $250,000 or more can afford at least 80% of home listings.

Conversely, those earning below $75,000 have seen their market access diminish. A buyer with a $50,000 salary can afford just 8.7% of available listings in March.

This ongoing situation is exacerbated by the pandemic-driven surge in home prices, which are still nearly 40% higher than pre-pandemic levels in March 2019. Consequently, lower-income Americans have been significantly impacted.

Rising Rental Costs Affect All Income Levels

The 2024 “Rental Market Report” from Zillow indicates that rental growth has also surged. The data shows:

Rents now sit 10% above what they would have been had the 4% growth trend continued over the last five years.

The income needed to afford rent jumped to $78,592 in December, with the typical asking rent for single-family homes at $2,174, up 4.4% from last year.

Student Loan Collections Add to Financial Burden

Recently, the U.S. Department of Education resumed collection efforts on defaulted student loans, creating additional financial strain. U.S. Secretary of Education Linda McMahon reported:

More than 42 million Americans hold student loans, totaling over $1.6 trillion in outstanding federal education debt. Currently, over 5 million borrowers are in default, and this could increase significantly in the coming months.

This financial pressure contributed to last Friday’s decline in the University of Michigan’s consumer sentiment survey. The index dropped to 50.8, down from 52.2 in April, reaching its second-lowest level on record.

Consumer Resilience Amid Economic Disparities

Although economic data may show resilience among consumers, this masks the struggles of lower-income Americans. The spending habits of wealthier households are significantly driving retail demand, overshadowing the stagnation or decline in spending among those with lower incomes.

According to the Fed’s report, “A Better Way of Understanding the US Consumer,” retail sales estimates show that:

Consumer resilience has been driven by middle- and high-income households, while low-income households have pulled back since mid-2021.

Understanding the “Wealth Effect”

The concept of the wealth effect explains how perceptions of financial well-being influence spending. Simply put, when individuals feel wealthier, likely due to increased asset values, they tend to spend more. This phenomenon emphasizes the growing disparity as higher-income Americans continue to spend significantly more than their lower-income counterparts.