Written by Davide Barbuscia and Lewis Krauskopf
NEW YORK (Reuters) - Moody's U.S. debt downgrade has raised concerns that investors can reassess their demand for U.S. government bonds and potentially increase yields to put pressure on trading at high valuations.
Moody's decision to lower U.S. debt ratings later last week, as government debt increases and interest expenses rose, has reignited concerns about a wider range of investors reassessing U.S. sovereign debt, which could increase economically-wide borrowing costs.
"Every time this happens, investors think maybe more should be transferred to the U.S.," said Campe Goodman, fixed income portfolio manager at Wellington Management.
The benchmark 10-year yield impacted mortgage rates and borrowing costs for companies and consumers, rising to more than 4.5% early Monday, but the sell-off then dropped to the moderator. The rate of return is inversely proportional to the price. The sell-off in the bond market continued Tuesday, with a 10-year yield of 4.48%, slightly higher than the closed position on Monday.
The longer 30-year yield is higher, reaching a high of over 5% at Monday's highest level and flirting with that level again on Tuesday.
Analysts and investors say higher yields have an impact on stocks because they represent higher borrowing costs for companies and greater competition for investments from fixed income.
Matthew Miskin, co-chief investment strategist at Manulife John Hancock Investments, said a 10-year gain of more than 4.5% could be a headwind for stocks. "I think which markets are working to solve, and if there is a 30-year explosion, does that mean the rest of the curve is next?" Miskin said.
Inventory presence has been under pressure in some cases over the past few years, when fiscal yields rose above 4.5%, and yields rose sharply, often negatively correlated with stock performance. A prominent example is the end of 2023, when the S&P 500 index fell sharply as 10-year yields rose to 5%.
Michael Wilson, an equity strategist at Morgan Stanley, said Monday that stock market valuations have been “significant” at 4.5% in the past two years, and stocks tend to face valuation pressure when 10-year yields violate that threshold.
According to LSEG DataStream, the S&P 500 has a P/E ratio of 21.7, with its long-term average well above its long-term average of 15.8, according to LSEG DataStream.
However, Wilson said that while the 10-year yield is more than 4.5%," he said in the notes that we will be the best-selling buyer of this kind.
As Republicans in Congress seek to approve a big tax cut aimed at boosting economic growth, while potentially adding $36 trillion in U.S. public debt piles, this has heightened concerns Moody has highlighted on the U.S. fiscal trajectory.
This also follows a war of the trade war triggered by President Donald Trump’s tariffs on U.S. trading partners. Although tariffs are largely seen as an obstacle to the economy, recent trade breakthroughs with China have sparked optimism that their impact will be softer than people fear.
"You're going from a temporary fear of inflation with low growth and tariffs to a better growth background, but maybe not a better inflation or fiscal background, because you're still pushing this huge tax bill."
Federal Reserve officials said on Monday that Moody's downgrade could have an impact on the U.S. economy by raising the cost of capital.
Analysts at BOFA Securities said in a Monday note that downgrades are unlikely to trigger mandatory sales of the treasury, as major fixed income indexes require only securities to maintain investment-grade ratings or do not have specific sovereign rating guidelines.
Nevertheless, this could lead to a steep earnings curve as investor sentiment worsens the long-term outlook for U.S. debt.
"There was a time when the bond market was very worried that we would continue to stimulate an economy that was not weak," Goodman said.
(Reported by Davide Barbuscia and Lewis Krauskopf; Editors by Megan Davies and Aurora Ellis)