22 May 2025
Dear Fintax Investor
Last week, ratings agency Moody’s downgraded U.S. sovereign debt from Aaa to Aa1, aligning with earlier downgrades by Fitch (2023) and S&P (2011). This marks a historic shift, ending the U.S.’s century-long triple-A status, the gold standard for sovereign debt safety, and challenging its historic status as the world’s safest trade during times of increased uncertainty. With U.S. federal debt at $36.2 trillion (124% of GDP) and interest costs projected to exceed $1 trillion, the “risk-free” status of U.S. Treasuries is now under scrutiny.
The market reacted sharply on the downgrade announcement. The 30-year Treasury yield briefly hit 5% post-downgrade, and the 10-year yield reached 4.5%, reflecting a higher risk premium demanded by investors for holding U.S. sovereign debt. Despite the U.S. real interest remaining positive at 1.5%, the price of gold as an alternative store of value continues to rise, serving as another signal of investor uncertainty about U.S. debt safety.
Historic Price to Earnings (P/E) ratios (averaging 15-17x over 100 years) have relied on the U.S.’s reserve currency dominance and the perceived safety of holding U.S. treasuries. The debt ratings downgrade may now result in the elevation of equity risk premiums, potentially compressing price multiples, especially in rate-sensitive sectors. Lower P/Es and therefore higher earnings yields may now become increasingly attractive to investors, signally a shift towards more traditional ”Value” and away from ”Growth”.
To navigate the volatility, Morningstar are increasingly diversifying the Fintax Funds across regions (e.g., Europe, Asia, emerging markets), asset classes (e.g., shorter-duration bonds), and investment styles (e.g., Value, Growth, Quality) and finding opportunities within nimbler, smaller market capitalisation companies. Real interest rates in emerging markets are becoming increasingly attractive on a relative basis (emerging markets such as Brazil and Mexico are delivering 9.2% and 5.3%, respectively).
This latest downgrade challenges the U.S.’s “risk-free” status, potentially reshaping global finance. Diversified portfolios can mitigate risks and seize global opportunities, providing some stability in an evolving market landscape.