Sentiment Sinks, Yields Rise, and Moody’s Chimes In

Moody’s just downgraded the U.S.—but does it matter? Let’s talk deficits, sentiment, and why this could still be an investment story.

KEY TAKEAWAYS

• Consumer sentiment plunged to near-record lows, driven by tariffs—not inflation
• Moody’s downgraded the U.S. to Aa1 due to growing deficit and fiscal pressures
• Bond yields rose slightly in response to perceived risk premium
• Deficit spending may be reframed as future-facing investment, not just a liability
• Markets reacted calmly, viewing downgrade as expected and largely symbolic

MY HOT TAKES

• Tariffs—not just inflation—are increasingly shaping consumer expectations
• A downgrade to Aa1 still means "very low credit risk"—this isn’t a crisis
• Independents are oddly optimistic—possibly driving continued consumption
• High bond yields are compounding deficit woes by raising debt service costs
• Deficit reduction for ideology’s sake could undermine future U.S. strength
• You can quote me: “Increasing the deficit to invest in future growth for the US is indeed worthwhile, and some would argue, a necessary investment to ensure that future generations inherit a strong economy.”

Don’t stop ‘til you get enough. Despite gains in stocks, markets were treated to a rash of troubling reports on Friday. After the session closed, traders were treated to a sour cherry on top when Moody’s downgraded the US. Let’s run through it all and see where we end up.

I must start with one of my favorite leading indicators, consumer sentiment, specifically, University of Michigan Sentiment. I like this series for a number of reasons, the least of which is that it provides a preliminary release early in the month. The index is also pretty comprehensive allowing economists to get, what I certainly believe, is a good handle on what consumers–the engine of economic growth–are thinking these days.

So what are they thinking? Well, how about the headline number, which was the second worst on record, only rivaled by a print which happened when inflation peaked a few years back. This time around, it is not inflation that is vexing consumers, but tariffs and their all-around nasty side effects, least of which is old-friend inflation, and consumers are expecting it to rise. Economists were hoping for a gain over the prior release, and they were disappointed. Before we go any further, it is important to recognize that Friday’s numbers reflect surveys taken prior to the administration’s cooling down tensions with China.

Aside from its timeliness, I like the Michigan survey because it breaks down results by political party. As you might guess, sentiment does vary based on political party affiliation, with sentiment tilting more positive when the respondents party is in the Whitehouse. If we dig into the latest release, we see a notable, across the board decline in sentiment in both Republicans and Democrats. Interestingly, and I have no explanation for it, Independents are becoming more confident. Perhaps it’s the Independents and their credit cards that are keeping the economy moving forward. I am not joking. Many detractors from the sentiment indicators reference the low correlation between sentiment and actual consumption. But that anomaly is only a recent development, specifically since the pandemic. Maybe it is a YOLO (you only live once) thing. That said, a declining consumer sentiment number across the two major political parties cannot be a good thing. Just how bad is still up in the air.

Speaking of up in the air. The US’s credit rating got demoted on Friday by Moody’s to one notch below its top rating. The company cited many reasons, but the principal driver was the swelling US budget deficit. Moody’s was the last of the three major ratings agencies to strip the US of its gold star rating and it was largely expected by most analysts and economists. 

The Federal Budget deficit, now running around $2 trillion dollars, is always a lightning rod for political debates. It has recently been thrown into sharp contrast with lawmakers debating the so-called “Big Beautiful Bill,” which is set to have big and beautiful-to-some tax breaks. However, less taxes for citizens and companies means less revenue for the Government. If the Government wishes to maintain current spending levels, it will effectively increase its deficit. The challenge is how to pay for the shortfalls, and that is where the real debate begins. I won’t get into it today other than to point out that certain expenses CAN be controlled by the Government. However, there are some expenditures that cannot be controlled by lawmakers. For example, persistently high bond yields mean that the Government must spend more to service existing debt, confounding an already untenable situation.  

So, yes, the deficit is growing and upcoming policy changes imply that the deficit will grow yet further. Let’s take a step back for a minute. Moody’s mission is to appraise credit worthiness of companies and sovereigns. When it comes to debt, investors are keenly interested in knowing that the issuing entity can afford to make its coupon payments and return principal when the debt matures. The higher the likelihood of a default, the lower the rating. Let me ask you a question. Do you think that the US would default on its sovereign credit obligations?  Of course, it won’t, and guess what, neither does Moody’s. Its Aa1 rating is described by the company as follows : “Obligations rated Aa1 are judged to be of high quality and are subject to very low credit risk.”

There you go, subject to very low credit risk. “Low” doesn’t mean, or even imply “no.” Therefore, default is not out of the realm of possibilities, just highly unlikely. As of this morning, longer maturity bond yields have risen, which makes sense as yields adjust to factor in the additional “known” risk. The market–aka the Bond Vigilantes–decides how much risk premium is required to compensate for the additional risk. Right now, that looks like 5 basis points for 10-year notes and around 7 basis points for the 30-year bond. Interestingly, the Dollar Index is slightly lower this morning indicating that the “sell America” trade may be back.

Going back to my blog post from May 5th “Don’t Bet Against The US - It Doesn’t End Well”, I would like to reiterate for the record, it doesn’t. Now a word about the deficit and the growing debt needed to finance it. At a very basic level, a swelling deficit is certainly not a good thing, but–controversial question–is it such a bad thing? 

As aforementioned, some of the deficit increase is caused by high yields. But let’s remember, some spending, deficit or otherwise, IS ABSOLUTELY CRITICAL to maintain a dominant global economy. The US absolutely needs to invest in US companies, US infrastructure, and yes, even the US consumer. US consumers like to spend money, and the more they have, the more they spend. Tax cuts put more money in consumers’ pockets. 

But what about corporate tax cuts? Lower corporate taxes level the playing field giving US companies an advantage over its foreign competitors. One cannot argue that this is an unworthy investment. Ah, there it is, the word investment. Increasing the deficit to invest in future growth for the US is indeed worthwhile, and some would argue, a necessary investment to ensure that future generations inherit a strong economy.

At the end of the day, of course the Treasury must mind its finances, just like you and me. However, cutting the deficit for ideological reasons at the expense of consumer and corporate health is simply irresponsible. So, what about the Moody’s downgrade? I would say that Treasury Secretary Bessent’s quote to Kristen Welker on this weekend’s Meet the Press, says it all. The rating cut is a “lagging indicator.” In other words, it is a tempest in a teapot.

FRIDAY’S MARKETS

Stocks rallied on Friday on continued relief that the President is making headway on striking trade deals. Consumer sentiment logged its second worst reading in history and markets shrugged it off because American consumers apparently chose retail therapy when worried about their financial prospects. Housing starts and new building permits all came in soft on Friday as housing arch-nemesis Treasury yields gained.

NEXT UP📈

• Leading Economic Index (April) is expected to have declined by -0.9% after slipping by -0.7% a month earlier.
• Fed speakers today: Bostic, Jefferson, Williams, Logan, and Kashkari. A full hand of opinions is expected, none likely to sooth equity traders.
• Later this week: still some more important earnings releases along with flash PMIs, more housing numbers, and some more regional Fed reports. Download the attached calendars so you can beat the horde.

DOWNLOAD MY DAILY CHARTBOOK HERE 📈

DOWNLOAD YOUR ECONOMIC CALENDARS HERE 📅

DOWNLOAD YOUR EARNINGS CALENDAR HERE 📅