Does Moody’s U.S. Debt Downgrade Even Matter?

Jeff Buchbinder (00:00):

Hello everyone and welcome to LPL Market Signals. Jeff Buchbinder here with my friend and colleague, Jeffrey Roach. Jeff, have you seen the LPL commercial, "What if You Could?" With Anna Kendrick?

Jeffrey Roach (00:15):

Very fun. Yes, I have. That turf she's dragging through the city sure gets heavy. Love it.

Jeff Buchbinder (00:24):

She's stronger than she looks

Jeffrey Roach (00:26):

<Laugh>. Right?

Jeff Buchbinder (00:28):

Well, I'm going to give all of you listeners some homework here. If you go, you can find the commercial on whatifyoucould.com. This is probably best for folks who really know our firm well, there is a hidden nugget in there that most people are not seeing, which I actually thought was pretty neat. So look for a hidden nugget for you folks who know LPL well, LPL advisors, LPL employees. See if you can find that nugget and get back to me and let me know. Apparently very few people are actually seeing that. So

Jeffrey Roach (01:05):

Hey, and I'm not one of the few because I do not know what you're talking about. I'm going to, you have piqued my interest. I'm going to listen to it and watch it again.

Jeff Buchbinder (01:13):

We don't give homework often.

Jeffrey Roach (01:15):

In slow motion.

Jeff Buchbinder (01:15):

But now we are giving homework. So it is May 19, 2025, as we're recording this. Stocks have rallied back after opening week, after the news over the weekend about the U.S. debt rating getting downgraded. Certainly we'll talk about that. That is agenda item three on our list here. We'll start with a very quick recap of the market rally last week. It was quite a rally. Then agenda item two sentiment gets a jolt, which is the title, Jeff, of your Weekly Market Commentary for this week. So you can find that on lpl.com. Jeff will go through the key messages from that publication and then we'll of course wrap up with a week ahead, as we always do. It's pretty quiet week, so I suspect that that preview will be quick as well. So here's your recap. Second best week of the year.

Jeff Buchbinder (02:13):

Why did we get such a big rally in the stock market? Of course, because China paused tariffs. That was the majority of it. But then you also got some pretty good AI headlines later in the week as President Trump embarked on his Middle Eastern tour and got some big AI deals with Saudi Arabia. The S&P was up over 5% for the week and actually was up every day, all five days last week. The rebound off the lows in early April is now about 20%. So a very powerful rally. We're getting pretty close to where these types of rallies tend to tire out, so we'll see how much further we can go in the short term. But it's been quite a powerful rally on historical perspectives. The S&P's now down about, or now up about 1.8% for the year and is just 3% away from its February highs.

Jeff Buchbinder (03:14):

So really, really strong. Tech led of course you would expect on good tariff news for tech to lead, but you also got the AI headlines giving it another boost. So that was the leader. And then healthcare was the laggard on well, healthcare lagged because it was defensive, but it also lagged because United Healthcare was down over 20%. So a couple of things going on there. International markets have a real hard time keeping up when the U.S. rallies, especially when it's tech led. So indeed that was the case. The international markets up, but not up as much as the U.S. Here's your bond market. This of course, is getting a lot of attention today. We are down a little bit on the broad Bloomberg Bond Market Index, down 0.2% for the week. You had actually a little bit of dispersion though within the categories. Preferreds did well, you know, certainly financials are in good shape. That makes up the bulk of the preferred index. And then high yield actually did pretty well. That makes sense because high yield is equity sensitive. So as the, you know, the market priced into a better economic outlook with lower tariffs it makes sense that high yield would lead. But the you know, 10-year yield was, was up a little bit last week and is up again today. Any comments on any of that, Jeff?

Jeffrey Roach (04:45):

Well, good. This is all about the rebound off of the better news from the tariff front. Certainly pretty broad based. I think you're going to talk about that in just a little bit, fairly broad based. That's certainly good news.

Jeff Buchbinder (05:02):

Yeah, absolutely. And it makes sense that you would start this is you know, intraday, so to include some of the action on Monday, but makes sense that gold would be a little bit faded as the market goes risk on, and that's certainly what we saw last week. And then you got a little bit of weakness in the dollar today on the U.S. debt downgrade kind of carrying on. Last week wasn't much of a move in the dollar, but certainly the news over the weekend was dollar negative. Here's, I mentioned the S&P's up, you know, up on the year and now only 3% shy of its record high from February. So at least when I price this chart, 5,924, and we've seen pretty good breadth readings. Typically it's a really positive signal if you have over 90% of the S&P 500 above its 20-day moving average.

Jeff Buchbinder (05:57):

We are really close to that. We got to 88 and change at the high last week, and now we're, you know, 86 and a half and we'll see what happens the rest of the trading day today, but could potentially add a little bit to that statistic. So let's go to the weekly Jeff. Again really about the change in the narrative after the White House cut the China tariffs and then they followed up with cutting their tariffs on U.S. exports to China. Big sentiment boosts. So you cover a lot of different topics in this piece. You cover, you know, a little bit about the Fed, a little bit about the debt downgrade, a little bit about tariffs, cover a lot. So, I guess the high level question with the economy anyway is, is how much has really changed?

Jeffrey Roach (06:50):

Yeah, I think the real top line is this, you know, 2025 still has a little bit more headwinds than 2024. That's kind of a one key takeaway, and one of the reasons why I make that case is I start looking at, and I show this in the piece, where even after you have these fairly, you know, interesting moves and positive notes coming out of the U.S.-China meeting in Geneva, which was not just this past weekend, but the weekend before, you have effective tariff rates still higher than they were last year, but a lot less than they were. And they were projected to be just, you know, before that meeting. So in some ways you could say what's changed is maybe the headwinds post April 2 is maybe softening, a little bit of backpedaling. Tariffs are not going to be as much of a drag, but it will still be a drag.

Jeffrey Roach (07:50):

And maybe the kind of the close corollary would be maybe recession risks aren't as high, but we still have a slowdown in growth. And the biggest, I think the biggest thing you got to work through, I think from an asset allocation standpoint is what sectors of the market will be most hit by just plain old uncertainty where businesses are uncertain about when and where and how much to put out for capital expenditures in 2025. You know, we ended 2024 with a position where businesses were ready to put some cash to work, you know, upgrade some equipment, capital expenditures were set to rise. Now that's uncertain. So just want to briefly show what I'm, explain what I'm showing here in this graph. ETR effective tariff rate. So that's perhaps the biggest you know, elephant in the room. What in the world are those acronyms mean that I'm highlighting here?

Jeffrey Roach (08:50):

And the point is that, you know, after those meetings just in the last couple of weeks here trying to understand how bad it's going to be with, particularly with our China, U.S. trade relationship, you got to remember 2024, we still had some lingering tariffs from Trump 1.0 and that was also extended through the Biden administration. That's why we have a fairly high effective tax rate, tariff rates in China. But 2025 was on top of that. So, I talk through the idea that as we remove some of those headwinds, markets are certainly going to respond. I think that's one of the main things one of the catalysts that you highlighted, Jeff, as we're talking about, you know, you know, 20% off the lows and we're getting very close to the highs of earlier this year.

Jeff Buchbinder (09:42):

Yeah, certainly pricing in a lot of optimism. I mean, we're generally optimistic too, but we certainly don't want to dismiss the concept of these tariff rates going back up. Right. And then, you know, you talked about capital expenditures and all of that, there's still trade uncertainty. So, you know, companies could still be hesitant to invest. And then of course we have a little bit of an inflation bump that's likely coming. We heard that from Walmart last week. So, this market is pricing in a fairly optimistic scenario for economic growth, for inflation, for profits. Maybe it's a little bit, you know, time for a little bit of a pause. At least that's our view in LPL Research. So Jeff, turn to this concept of U.S. exceptionalism. It's been kind of under attack over the last several months. So you know, you're trying to make a case that it's really not going away.

Jeffrey Roach (10:41):

Right. And I think another thing we want to talk about too is, you know, as the LPL Research team has been working through this for quite a while now, especially, you know, after you know, some of the risks that were emerging in March and then April, of course here we are in May, thinking about U.S. exceptionalism is much deeper than just the fact that our markets and the rallying that we saw in big tech was so pronounced you really couldn't avoid it. Exceptionalism I make the case is much deeper than that. It's more foundational than that. And it's based on a couple things. One is just the raw size of our capital markets. And so I put this chart together to illustrate that. Just, the raw breadth and depth of capital markets. Look at the biggest capital market in the world equity market that is as a percent of global market capitalization is the New York Stock Exchange that's top.

Jeffrey Roach (11:40):

You go to the second one that's also in this country. So the first one's a U.S. market, the second one is a U.S. market. You have to go down to the third largest to go outside of the U.S. and it's quite a jump. And that's what I'm showing here in the bar chart here. You're going from, you know, roughly 25% down to roughly 7% in terms of market cap. And that's a sizable jump. And it illustrates that when you're looking for consistency in liquidity, when sovereign wealth funds, central banks want to move assets around, they, you know, they'll find the most liquid market here in the United States. That's certainly exceptional. And that addresses those fundamental market structure concepts. I think it's extremely important to think of it that way.

Jeff Buchbinder (12:34):

Yeah. It gives companies in the U.S. access to capital, right? That's right. That's, and that's of course, the engine of growth. So definite advantage for the U.S. The U.S. also has an advantage in terms of the U.S. dollar being the global reserve currency. And it's more than that means sometimes you hear that phrase and people just don't quite understand exactly what it means. It means different things to different people. Well, one of the things it means is that most of the global transactions are in the dollar, right?

Jeffrey Roach (13:05):

That's right. So when you think about exceptional concepts within the U.S., in addition to, you know, AI and big tech Mag seven, in addition to fairly robust economic growth, you, I just highlighted the market cap component. I think the second fundamental market structure that is really important to that exceptionalism. That's not going to reverse in a day. I think that's kind of the key here is the fact that when you look at international allocators, not just for-profit, but not for profit entities, those institutions hold a large amount of dollar denominated assets. Hence that's the idea here that we're showing in global currency reserves. And yes, if you want to take the bear case, in the late nineties, we started the 2000s with the U.S. dollar making up roughly 70% of global currency reserves.

Jeffrey Roach (14:09):

We're now to about 60. But it's really a matter of diversification. As other markets mature, it's not necessarily the fact that, you know, there's a, you know, a significant risk of diversifying away in a sizable fashion, a large magnitude away from U.S. dollars. So, that's another component, which by the way, this is a little segue. I know we're going to talk about the Moody's downgrade. So the Moody's entity, the rating agency downgraded ratings, but it also in the same report upgraded the outlook from negative to stable. And one of the reasons why they upgraded that outlook. U.S. economic outlook is because the benefits of the U.S. holding a global reserve currency. We'll talk more about that in a future slide.

Jeff Buchbinder (15:02):

Excellent segue. So let's turn to that downgrade. I mean, I just posed the question, does it even matter? You could argue maybe the markets today are telling you it doesn't because as of now, at least, you know, right before we started this recording, I checked the quotes and, and yields, 10-year yield and 30-year yield had barely budged. They were up this morning and came right back down. So hard to know exactly what's going on there, but part of what's going on is the market is seeing value in Treasuries when yields get higher. I think the five year yield peaked at like 5.04, 30-year Treasury yield peaked around 5.04. It's now back down. The 10-year is around four and a half. We've been comfortably in that range for a while. So I'll show you a chart of the 30-year here in a minute, but just for now, and I think it'll continue.

Jeff Buchbinder (16:02):

The markets are digesting this well. So with the help of Lawrence Gillum, our chief fixed income strategist, I tried to put these, you know, four bullet points together to just sum up where we are on this. And you know, here are your key points. First, you know, the downgrade from Moody's from Aaa to Aa1, they cited debt and deficit concerns. Well, those aren't new. We've had debt and deficit concerns for decades, right. And it has gotten a lot worse since COVID, no surprise to anybody. I mean, that's why Fitch downgraded us a couple years ago, and that's certainly why S&P downgraded us in 2011. This was, I don't think any surprise given that Moody's downgraded the outlook from stable to negative in 2023. And as I mentioned, the other two major agencies had already made this move.

Jeff Buchbinder (16:58):

Practically speaking, we don't think this really is going to change anything. Right? And you're seeing that again in the markets today. As the market assesses credit risk of the U.S. government, they are not going to be influenced by credit agencies that have a history of being backward looking and being late. Mm-Hmm. Markets are much smarter than these credit agencies. Certainly that was proven in 2008, but that was very complicated. But generally speaking, throughout history, they're slow, they're going to be late. So, and especially Moody's <laugh>, right? They're way late. This was a much better move in in 2011 from S&P, and it made a lot of sense at that time. Still makes sense now. So really doesn't matter in terms of how Treasuries are viewed and traded. And then lastly, hopefully this will be a catalyst, right? We have a big time problem here with our deficit and given interest costs are rising because Treasury yields are rising, it's going to be more expensive for us to service this debt. And you end up potentially with a downward spiral if you're not careful. So I don't want to sound alarmist, but we're now at the point where historically, in terms of the percentage that the U.S. government spends on interest, where action is taken, sometimes the bond vigilantes come in and force action. But we would expect and whether it happens in this reconciliation bill or right after, we would absolutely expect some things to start happening. Otherwise the bond market is going to frankly punish the Treasury market. Jeff, your thoughts?

Jeffrey Roach (18:43):

Yeah. So the question that you posed, does it matter. Well, if you're talking about Moody's announcement, no, it doesn't matter. Yeah, they're late to the game. S&P changed in 2011. Then Fitch did their announcement in 2023. So Moody's, the third of the big three credit rating agencies actually hinted at it in 2024. Finally made a statement here just this past Friday, which by the way, they have a 21 point rating scale from AAA to C all the way down to lowest quality. And, you know, we had a one notch downgrade. So what's interesting to me is, you know, does it matter? Well, what does matter is the amount of interest payments not necessarily as a percentage of GDP. The ratio I look like to look at is interest payments as a percent of gross federal receipts, like tax receipts.

Jeffrey Roach (19:41):

So you know, what's coming in, what's going out from the budget standpoint of the federal government, we're actually seeing that ratio of interest payments as a percentage of federal tax receipts as high as it was in the mid to late nineties, but throughout the nineties, it had a downward trajectory and then held steady for several years, even through the Great Financial Crisis. So to me, that's the ratio, one of the ratios that does matter, at this point. It seems like, you know, markets have, have kind of walked past the announcement that Moody's made. So does it matter? Yes and no.

Jeff Buchbinder (20:25):

Yeah, great point about looking at tax receipts. I think we're you know, in the high teens in terms of that percentage I'm sure many of you heard that we're spending as much on interest costs as we are on national defense, which is not the way you want to do it. There's certainly been some push to rein in spending, you know, from the Trump administration, including DOGE and all of that. But it really hasn't moved the needle very much. We'll see, maybe Medicaid spending helps move the needle a little bit, but that is very controversial and they're having a hard time getting that through the House and Senate. So we'll wait and see. But so it's tough to be confident.

Jeffrey Roach (21:10):

You are, you are spot on, Jeff. High teens is exactly right. 17% to be specific, percent of tax receipts going to interest payments. And that's, like I said, that's as high as the early nineties. So that's something you have to watch, which by the way, I think it's so important to think about why labor participation rates matter, why job market matters so much, even if you have perhaps, you know, a softening on some portions of the tax receipt side of things. But if you have a larger pot of workers paying into that, ,you can manage through. That's why it's so important, again, look at do you have a healthy population that's working? That's a great variable that helps us offset that ratio of interest payments and such. So not to get too much into the weeds as that, but you're right, JB on the percent numbers.

Jeff Buchbinder (22:13):

Yeah, it's a great point. It's also why the stock market matters, right? Because the stock market rising means more capital gains. That of course helps the Treasuries coffers as well. So, good point there. Here's the 30-year Treasury yield when we're not at the highs from 2023 yet, but if you look at the, I know this is a little bit tough to see, but if you look at the 5% level here that we, you know, we just hit today, that's pretty much right where the White House capitulated and you know, put on, took, put the 90 day tariff pause on all tariff rates except China. And then later, of course, as we know about what, nine days ago or so, put the 90-day pause on China tariffs as well. So, that level, I mean, Treasury Secretary Bessent said he's targeting the 10-year yield.

Jeff Buchbinder (23:10):

This is the 30, more sensitive to deficit concerns, but the same concept holds here. We had this big sell-off and that in bond market on the tariff news and you know, Bessent was able to talk President Trump into issuing that pause and kind of taking the heat down. So hopefully this range holds if not, there's a little bit of upside to that 2023 level, I don't know the exact rate, but somewhere in the, you know, five two kind of a range. So I mean, if we do break through five at least we'll have that October, I guess it was 2023 high to fall back on. And hopefully that holds if this range does not, we're not quite overbought technically, can see the RSI 14 around 63, so this is important to watch. And the 10-year yield, again, around four and a half also very important to watch.

Jeff Buchbinder (24:08):

That's kind of your best barometer in terms of whether the market cares about the debt downgrade or the, in general, the credit risk associated with Treasuries. And right now they don't. You know, economic growth and inflation affect Treasury prices, so you may still get a move higher. Lawrence likes the idea of buying the 10-year Treasury between 4.75 and five. So we'll have to watch, see how high we get, but at those levels, it starts to get more attractive and maybe we'd think about buying more bonds. So let's turn to the week ahead, Jeff. Where I would say it's a quiet week, which means that you know, earnings maybe will get more attention then they might otherwise get. And I know we have a few Fed speakers. So what are you looking for this week?

Jeffrey Roach (25:06):

I think it's important to be tracking the overall theme that these Fed speakers will be talking about. This week's, you're exactly right, in terms of the economic data released, it's not a big one. In fact, our listeners should know that, you know, on the top of the list, of course, is a non-farm payroll number that comes out the first Friday of the month. So this time of the month, you know, we're waiting for deflator numbers, of course, we'll wait for the beginning of the next month. This week's not going to be a big one. We're going back to the speeches, we're really going to focus on what the speakers that these individual Fed speakers are going to be saying about how long can the Fed wait before they have to do something, before they feel like they really need to do something.

Jeffrey Roach (25:53):

You know, at this point, the consumer's holding up, the labor market's holding up, and inflation's still running a little bit hotter than they would like. So the Fed's saying, okay, we're going to wait and see. There's no emergency, there's no strong reason to act. And so that's going to be kind of the subtle theme I'll be looking for when I'm listening to the speeches this week. And then, of course, Jeff, you're going to be covering some of the individual company releases and what senior leadership will be talking about, particularly when it comes to inflation and tariffs.

Jeff Buchbinder (26:29):

Absolutely. Yeah, so we get Home Depot tomorrow and Target on Wednesday. I think Target's going to be really interesting in the wake of the Walmart report last week and little dust up they had with the White House, because they're saying they're going to have to pass along some of the tariffs and, you know, a lot of their prices are going to go up and all of that. I mean, Target's going to have to pass along some of these tariffs to consumers too. There's just no way around it. Retailer margins are not particularly wide. You know, it's just a question of how much. I saw an interesting study from our friends at Evercore ISI, the sensitivity analysis around how much of the tariff costs are eaten you know, by companies in the S&P 500, and then what are the average tariff rates?

Jeff Buchbinder (27:19):

Well, if they're, let's just say they're 15, which is a reasonable estimate at this point. You know, we get 10% universal plus, you know, autos and steel and aluminum and extra tariffs on China and all that. So let's just say 15, if companies eat half of those tariffs and pass the other half on, Evercore estimates it's a 3.1% hit to S&P 500 profits. That is, it doesn't sound like a lot, but that's a pretty decent hit, right? You'd expect a 3% hit to earnings to be followed up by a bigger hit to the price of the S&P 500. So, you know, maybe that's enough to drive a 5% pullback or more. We'll see what we actually get. Some of that weakness is already in the market, but that's just a simple example to illustrate just how hard these things can bite.

Jeff Buchbinder (28:18):

Even if they eat half you're still going to have margin pressure. You're still going to have a hit to earnings. So it'll be interesting to see what Target does here. They're in a really tough spot. <Laugh>, you know, everybody says the Fed's in a tough spot. Well, what about these retailers who could potentially draw the ire of the White House? We'll have to see how Target handles it, but they got to be careful here. So we're only about 20 companies away from being done with earnings season. Most of the numbers are in, they're not going to change. It's really more about messaging. These later companies have more to react to. And retail in particular is particularly hard hit by tariffs. They report late. So for that reason, it's going to be interesting to hear from these two companies and the other retailers that report this week. So that's what I am going to be watching for sure.

Jeff Buchbinder (29:14):

Alright, so with that, let's go ahead and wrap up for the week. Thanks, Jeff for jumping on and walking through your Weekly Market Commentary. Again, you can find that on lpl.com. You can find all of our weekly commentaries on the research tab under lpl.com. And also, don't forget your homework. Go to whatifyoucould.com and watch the Anna Kendrick LPL commercial and look for a little nugget for you folks, again, that know LPL well look for the hidden little nugget there that I thought was quite clever and it seems like most people are missing. So including our own Dr. Jeffrey Roach, <laugh>. So with that, we'll wrap, Jeff's going to scurry off and go find that right now. As soon as we're done.

Jeffrey Roach (29:58):

And slow motion even, I'm going to just play it at, you know, half speed.

Jeff Buchbinder (30:03):

Play it in half speed and watch carefully <laugh>. So everybody have wonderful week. Thanks for joining LPL Market Signals. As always, we appreciate it. And we'll see you next time. Take care.