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What happened?

Credit ratings agency Moody’s downgraded the US sovereign credit rating by one notch on Friday to Aa1, citing continued growth in the national debt and rising debt servicing costs amid still-high interest rates. With this latest action, the US government has now lost its last remaining AAA rating from a major agency; S&P downgraded the US in 2011, and Fitch followed in 2023.

The downgrade came shortly after the House Budget Committee failed to advance President Trump’s “One, Big, Beautiful Bill” to extend the 2017 tax cuts, reflecting ongoing divisions within the Republican majority over spending and deficit reduction. Late Sunday, changes to appease fiscal concerns saw the tax bill advance through the committee along party lines, setting up potential passage in the House later this week.

At the time of writing, S&P 500 futures were 1.2% lower, and the 10-year US Treasury yield is up 9 basis points to around 4.53% at print.

What do we think?

The move should not come as a surprise. The federal government is running a budget deficit in excess of USD 2 trillion per year, even after a period of strong economic growth and low unemployment, and net interest costs now absorb 18% of tax revenues. But while the US debt trajectory has been worsening and is the reason for the Moody’s downgrade, this is already well known by investors.

Significant selling of US Treasuries is unlikely, in our view. While yields may move 10-15bps higher in the short term, as seen after the 2023 Fitch downgrade, the Moody’s move is unlikely to trigger significant selling or changes in collateral haircuts, in our view. Most investment mandates do not require AAA ratings for US Treasuries, and central banks continue to value the Treasury market for its exceptionally deep liquidity.

The US has very high credit quality, in our view, and aside from cash, US Treasuries remain the lowest-risk and lowest-yielding USD asset. The strength of US capital markets, the dollar’s reserve currency status, and the significant wealth held by US households mean that the US’s ability to repay debt is not in question, in our view. Academic research also shows that for countries with monetary sovereignty, rating changes have little lasting impact on short-term bond yields.

Credit downgrades are less politically costly in the US than you might think. The first US downgrade in 2011 was unexpected and triggered significant bipartisan consternation. But it ultimately resulted in few lasting financial or political repercussions. The 2023 Fitch downgrade was largely shrugged off by policymakers. The 2025 Moody’s downgrade may be used as a political tool in near-term budget negotiations, particularly among lawmakers who believe that the current "One, Big, Beautiful Bill" does not do enough to shrink the deficit, but we think it is unlikely to alter the overall trajectory of US fiscal policy.

Equity investors are focused elsewhere. With Moody’s the third credit ratings agency to downgrade the US, we believe that the shock factor for investors has likely faded, and we would expect a more muted equity market response to Friday’s downgrade. In recent weeks, global investors have been more focused on effective US tariff rates, which we see settling in the 15% region—a headwind to growth but not enough to cause a recession, in our view. While budget negotiations and deficit implications may begin to have an increasing impact on markets in the weeks ahead, we do not think that the credit rating downgrade in itself will be a major focus for equity markets.

How to invest?
Overall, we view this latest credit action as a headline risk rather than a fundamental shift for markets. We would also expect the Federal Reserve to step in if there were a disorderly or unsustainable increase in bond yields. So while the downgrade may lean against some recent "good news" momentum, we do not expect it to have a major direct impact on financial markets.

Against this backdrop, we make several investment recommendations:

Seek durable income. While there is a risk that bond yields could rise further in the days and weeks ahead in response to the downgrade, and in anticipation of higher US fiscal deficits, we believe current (or higher) yield levels offer an opportunity for investors to lock in durable portfolio income. Our preference remains for medium-tenor USD bonds of around five years, but depending on the market reaction in longer-term yields, additional investment opportunities may emerge in the days ahead. We expect Treasury yields to fall into year-end and believe high-quality government and investment grade bonds remain attractive for diversification and income.

Phase into equities. We recently cut our Attractive rating on US equities to Neutral, following the strong recent rally. However, our current Neutral rating on US equities should not be mistaken for a bearish view, and we continue to recommend a full strategic allocation. The recent earnings season has demonstrated the strength in structural AI earnings trends, we expect US stocks to move higher over the next 12 months, and we maintain our sector-level Attractive ratings on communications services, information technology, health care, and utilities. We also maintain strong conviction in the long-term potential of our Transformational Innovation Opportunity themes of Artificial intelligence, Power and resources, and Longevity.

Sell dollar rallies. The dollar has consolidated in recent weeks, following a spell of significant weakness in the immediate aftermath of "Liberation Day." We believe that this provides an opportunity for investors with excess USD cash, or international investors with unhedged exposure to US assets, to reduce their exposure to the US dollar. Over the longer term, we believe the trend of international diversification could lead to further dollar weakness, and particularly if the Federal Reserve begins to play a more active role intervening in bond markets amid high fiscal deficits.

Navigate political risks. Gold has reaffirmed its value as a hedge over the past year, and we continue to see its value as a longer-term portfolio hedge against downside scenarios. Over the long term, a weaker US dollar, persistent geopolitical pressures, and declining real interest rates should all support prices. We think a mid-single-digit percentage allocation to gold within a broadly diversified portfolio is appropriate for investors looking to manage political risks. We also see hedge funds as valuable diversifiers—whether through global-macro trading, market-neutral equity strategies, or agile multi-strategy platforms—capable of cushioning drawdowns when traditional exposures misalign. Amid geopolitical uncertainty, mounting fiscal pressures and shifting monetary regimes, they can dynamically adjust positions, judiciously deploy leverage, and hedge key risks. While careful attention to manager selection, liquidity terms, and incentive alignment is essential, a modest allocation to select hedge funds can enhance portfolio resilience and smooth overall return outcomes.