Once considered the ultimate risk-free asset, US Treasury bonds have lost their pristine AAA credit rating and America’s biggest customers are dumping their T bills to reduce their exposure to the increasingly belligerent and unpredictable US President Donald Trump.
As the analytical service IntelliNews Lambda reported, Russia already sold off its entire US treasury holdings after it was hit with the first oligarch sanctions in April 2018, but had already been winding down its exposure since the sanctions regime was first introduced following its annexation of Crimea in 2014.
China is at an earlier stage as tensions are not so high. But they have been rising and Beijing has also accelerated its sell off, reducing the outstanding volume by half to around $700bn now. However, the Russian experience shows that if the trade war with China escalates with a similar step-change event like the sanctions on Russia, it could exit completely very quickly in as little as 10 months or less.
Brazil and India are at an even earlier stage, but started to sell after the US weaponised the dollar and froze Russia’s overseas reserve assets in 2022 after the start of the Ukraine war. However, since Trump came into office a year ago they have both accelerated their sell off, IntelliNews Lambda reports, as Trump starts to systematically dismantle the international rules-based order and increasingly aggressively attacks friends and foes alike with everything from his Liberation Day tariffs to Black Hawk helicopters.
Trump is a catalyst for the downgrades, but mounting sovereign debt was already eroding the US standing and has now topped $37 trillion, or 120% of GDP – twice the 60% of GDP that the Maastricht treaty recommended as the maximum sustainable debt a country can carry.
US downgrades
The US was first downgraded from AAA in August 2011 by Standard & Poor’s, which cited political gridlock and concerns about fiscal and debt sustainability as the reasons.
More recently, in August 2023, Fitch Ratings followed suit, lowering the US sovereign credit rating from AAA to AA+ due to “a steady deterioration in standards of governance.” Partisan politics are increasingly fuelling a legislative gridlock that is preventing reforms and fiscal discipline. Trump in particular seems to be following a policy of simply trying to reverse any reforms the Biden administration put in.
In November 2023, Moody’s placed the US credit outlook on “negative”, signalling it could soon join the other two agencies in stripping the US of its last top-tier rating.
Investors are becoming increasingly concerned about the mounting levels of US debt. According to the Congressional Budget Office, the federal deficit reached $35 trillion at the start of this year and will top $37 trillion by the end. Interest payments on government debt are projected to surpass defence spending within a few years. Despite this, Treasuries remain highly liquid and widely held by central banks and institutions.
European downgrades
Europe’s leading economies have not been spared as they also suffer from sky high and growing debt on top of economic lethargy. France lost its AAA rating from S&P in 2012, with subsequent downgrades by Moody’s and Fitch. The UK was downgraded from AAA by Moody’s in 2013, followed by Fitch and S&P the same year. Germany, long seen as Europe’s safe haven, retained its AAA rating from Moody’s and DBRS Morningstar, but S&P cut its outlook to “negative” in 2023, raising concerns that even Berlin may not be immune.
Today, only a handful of countries still hold AAA ratings from all three major agencies — among them are Norway, Switzerland, Denmark, Luxembourg, Singapore, and Germany (though with risks). These nations benefit from strong fiscal positions, low debt burdens, and stable political environments.
EM upgrades
In the Global South things are going in the opposite direction for the biggest and fastest growing countries. Several emerging markets have seen ratings upgrades in recent years, reflecting improved fiscal management and macroeconomic stability.
India, while still below investment grade with some agencies, is now one of the fastest growing economies in the world and expects more upgrades. Indonesia, Mexico, and the Philippines have all reached investment-grade status. In 2023, Fitch upgraded Brazil’s outlook to “positive,” citing stronger-than-expected fiscal performance.
Despite the US T bill sell off, there is still a lack of attractive alternatives. The US bond market remains by far the biggest and most liquid fixed income market in the world, while other large and relatively liquid markets are in Europe, where the risks are also clearly rising.
Some commentators have speculated that if China were to dump all its $700bn of bonds rapidly it could be a “nuclear option” that would lead to a major US financial crisis has the cost of refinancing its debt would soar. While analysts say that it unlikely, and point to the some $25 trillion of liquidity in the market, it could absorb even a rapid Chinese sell off, which would hurt Beijing more than the US. However, if the attrition in both holdings and ratings continues, then eventually confidence in US T bills will erode, and the possibly of a step change event of massive selling will undermine America’s ability to refinance its debt and lead to server economic problems.
