This shift in sentiment is already visible in the bond market. Yields on benchmark 10-year Treasury notes, which are critical in determining mortgage rates and borrowing costs for both consumers and companies, briefly rose above 4.5% early in the week before stabilizing. Longer-dated 30-year bond yields climbed more sharply, topping 5% on Monday the highest level since November 2023 and hovered near that mark on Tuesday. The Moody’s US debt downgrade impact is clearly observable in these market movements.
Campe Goodman, a fixed-income portfolio manager at Wellington Management Company, noted that events like these often cause investors to move capital out of U.S. assets. Rising yields, which move inversely to bond prices, reflect growing investor wariness about the fiscal outlook and the potential need for higher returns to compensate for perceived risk.
Rising Yields Threaten Stock Market Stability
The bond market turbulence is rippling into the stock market. Higher yields typically pose a challenge for equities by increasing borrowing costs and making fixed-income assets more appealing by comparison. Analysts warn that if the 10-year yield stays above 4.5%, equity markets already trading at high valuations could face downward pressure. This highlights a critical impact of Moody’s US debt downgrade on equity valuations.
Matthew Miskin, co-chief investment strategist at Manulife John Hancock Investments, suggested that a breakout in the 30-year yield might indicate a broader rise across the yield curve, potentially dragging on stocks. Historically, sharp increases in Treasury yields have coincided with stock market pullbacks, as seen in late 2023 when the S&P 500 dropped significantly amid rising bond yields.
Michael Wilson, equity strategist at Morgan Stanley, emphasized that the 4.5% threshold on the 10-year yield has been pivotal for stock valuations over the past two years. Currently, the S&P 500 trades at a forward price-to-earnings ratio of 21.7, well above the historical average of 15.8, making it particularly sensitive to interest rate fluctuations. While Wilson acknowledged that rising yields could compress valuations, he also noted that temporary dips might offer buying opportunities, especially given recent positive developments in U.S.-China trade relations.
Fiscal Policies and Political Uncertainty Add to Investor Caution
The timing of the Moody’s US debt downgrade coincides with legislative efforts by Congressional Republicans to push through a sweeping tax cut package. While intended to stimulate economic growth, the plan could further expand the already ballooning $36 trillion national debt, heightening concerns about fiscal responsibility.
Adding to the complexity, recent signs of easing trade tensions between the U.S. and China have shifted market narratives. Ross Mayfield, investment strategist at Baird, observed that the market is moving away from fears of stagflation, marked by low growth and high inflation, toward expectations of stronger economic growth. However, he cautioned that this does not resolve inflation or debt issues, especially with expansive tax measures still on the table.
While analysts at BofA Securities downplayed the risk of forced Treasury selling due to Moody’s US debt downgrade, they warned of a potential steepening of the yield curve, with long-term yields climbing as investor sentiment deteriorates. Federal Reserve officials also acknowledged that the downgrade might increase the cost of capital, adding another layer of uncertainty to an already complex economic environment.
