MW Why corporate bonds may be 'fairly guarded' from Moody's downgrade of U.S. debt

By Christine Idzelis

'Uncle Sam has an ace up his sleeve,' says Bank of America's Joe Quinlan

Moody's decision to lower the rating on U.S. government debt seems unlikely to shake up the corporate bond market too much.

The downgrade may make "a little bit of noise," with long-term Treasurys appearing more sensitive to concerns about U.S. fiscal deterioration, said Luis Alvarado, global fixed-income strategist at Wells Fargo Investment Institute, in a phone interview Monday. But while "knee-jerk" reactions pushed Treasury yields higher, corporate credit should be "fairly guarded" from Moody's stripping the U.S. of its triple-A rating, he said, partly because companies' balance sheets generally appear to be in good shape.

Investors had been aware that the U.S. is running a large deficit, with its increasing debt levels putting it on an unsustainable fiscal trajectory, said Alvarado. "This has been cooking for a while," he said, explaining that worries over the deficit were already baked into bond prices and that other major credit ratings firms had already moved to strip the U.S. of its triple-A rating.

Long-term Treasury yields ended Monday modestly higher, with popular funds targeting the U.S. investment-grade bond market closing about flat.

For example, the Vanguard Total Bond Market ETF AGG, an exchange-traded fund that provides broad fixed-income exposure to investment-grade assets including Treasurys, mortgages and corporate debt, slipped less than 0.1% on Monday, according to FactSet data.

As for funds focusing on corporate credit, the iShares iBoxx $ Investment Grade Corporate Bond ETF LQD, which tracks an index of U.S. investment-grade bonds issued by companies, eked out on Monday a gain of less than 0.1%.

"I like to remind investors that Uncle Sam has an ace up his sleeve," which is the "resilient" U.S. private sector in which companies continue to drive growth and innovation, said Joe Quinlan, head of market strategy for the chief investment office within Bank of America, in a phone interview. Corporate balance sheets are generally in "good shape," after many companies took advantage of the low-interest-rate environment during the pandemic to refinance debt, he said.

Moody's announced on Friday after the close of the U.S. stock market that it lowered the credit rating of the U.S. to Aa1, from Aaa, because of the increase in its government debt and interest-payment ratios that are "significantly" higher than similarly rated sovereigns.

Read: Why Moody's stripping U.S. of triple-A rating is unlikely to spark a big selloff in Treasurys, according to UBS

"Moody's downgrade of the U.S. credit rating from Aaa to Aa1 appears to have been influenced by the pending fiscal package" in Congress, an economics analyst at Goldman Sachs said in a research note Monday.

The analyst said that Moody's projection for the U.S. deficit to reach 9% of its gross domestic product in 2035 is roughly 2 percentage points larger than Goldman's forecast.

"While we do not believe the downgrade would force any holders of Treasury securities to sell, it highlights the deteriorating fiscal outlook and comes at a time when markets are already attuned to fiscal risks," the Goldman analyst said.

The yield on the 10-year Treasury note BX:TMUBMUSD10Y rose 3.6 basis points Monday to 4.473%, leaving it up 30 basis points so far this month based on 3 p.m. Eastern levels, according to Dow Jones Market Data. Bond yields and prices move in opposite directions.

At the end of last week, Goldman Sachs lifted its 2025 forecast for the 10-year Treasury yield to 4.5%, from 4%, citing a cooling in trade tensions between the U.S. and China.

Tensions between the two countries had run high after President Donald Trump's April 2 announcement of "liberation day" tariffs sparked a global trade war. But the two countries recently agreed to lower the tariffs that each imposes on the other - at least temporarily - following tit-for-tat increases that took those levies to such extraordinarily high levels that investors feared a recession would ensue as a result.

After the "China truce," maybe the U.S. economy won't slow down as much feared, which means the Federal Reserve might cut rates as much as previously expected, said Alvarado.

Wells Fargo Investment Institute currently has a "favorable view" of investment-grade corporate bonds and is "neutral" high-yield debt, he said. High-yield bonds are riskier, as they're issued by companies with heavier debt burdens that risk making them more prone to potentially struggling to make their interest-rate payments in an economic downturn.

Alvarado said that Wells Fargo views intermediate-term maturities in the fixed-income market, ranging from three years to seven years, as a "sweet spot" for investors.

The potential for long-term rates in the bond market's so-called yield curve to move higher on concerns over the U.S. fiscal deficit represents a risk for investors. "If we are way too far out on the long end of the curve, and interest rates are set to move higher, then the bonds are probably going to lose value," he said.

In the meantime, investors will be watching to see how the tax and spending bill takes shape against the backdrop of worries that tariffs are weighing on the U.S. economy.

"It's important what type of legislation we get out of Washington," said Quinlan. "The key," he said, is to get the economy "back to speed" after its recent slowdown.

-Christine Idzelis

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May 19, 2025 20:20 ET (00:20 GMT)

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