Understanding the Impact of U.S. Credit Downgrades and Budget Challenges for Investors

by | May 21, 2025 | Insights

The recent decision by Moody’s to downgrade the United States’ credit rating from Aaa to Aa1 completes the trifecta of major rating agencies that have removed America’s top-tier debt status. Following Standard & Poor’s action in 2011 and Fitch’s downgrade in 2023, this latest move reflects mounting concerns about the nation’s fiscal health. The timing is particularly notable as Congress deliberates a new budget bill that could potentially increase annual deficits, highlighting tensions between tax reduction policies and fiscal sustainability. As these developments unfold, many investors are questioning how these fiscal challenges might affect their portfolio both now and in the long run.

Market volatility has often accompanied budget and debt ceiling disputes

Over the past fifteen years, negotiations around budgets and debt ceilings have repeatedly triggered periods of market uncertainty. Notable examples include the Standard & Poor’s downgrade of U.S. debt in 2011, the 2013 fiscal cliff standoff, and government shutdowns in 2018 and 2019. Despite these disruptions, compromises were ultimately reached in each instance, allowing markets to recover and continue their upward trajectory.

Interestingly, even after the unprecedented 2011 downgrade that prompted a market correction, the S&P 500 fully recovered within a matter of months. While seemingly contradictory, U.S. Treasury securities maintain their status as safe-haven assets during market turbulence despite these downgrades, continuing to function as crucial anchors for financial markets worldwide.

When considering national debt and Congressional budget conflicts, maintaining perspective is essential. As citizens and voters, concerns about the country’s unsustainable fiscal direction are valid. The reality remains that there are no simple fixes to these issues, with numerous commissions and initiatives failing to meaningfully reduce annual budget shortfalls.

Important as these fiscal challenges are, they shouldn’t prompt reactive changes to investment portfolios. Historical evidence shows that while past downgrades and fiscal challenges created temporary uncertainty, markets have consistently stabilized and recovered. Adhering to a disciplined investment approach centered on long-term objectives, diversification, and sound investment principles—rather than responding to Washington headlines or expecting Congressional deficit solutions—remains the most effective path to achieving financial goals.

Moody’s downgrade arrives at a pivotal moment when investor focus is shifting from tariffs to Washington’s budget proposals. While markets performed strongly following last year’s presidential election, partly due to anticipated pro-growth policies and extensions of the Tax Cuts and Jobs Act of 2017 (TCJA), the Moody’s announcement serves as a reminder of ongoing fiscal challenges.

In their assessment, Moody’s specifically noted that “successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs,” adding that they “do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration.”

 

Plans underway to extend or permanently establish Tax Cuts and Jobs Act provisions

Congress is currently developing a new budget bill with provisions still being refined. The current proposal seeks to provide certainty by extending the individual tax cuts from the TCJA, which are scheduled to expire after 2025. This would prevent a potential “tax cliff” scenario where rates would revert to pre-TCJA levels, possibly causing economic disruption. By addressing these issues well before expiration, lawmakers aim to create stability for both consumers and businesses.

The proposed tax package contains numerous provisions affecting individuals and businesses alike. Key components, which remain subject to modification, include:

For Individuals:

  • Permanent establishment of the TCJA individual tax rates, with a 37% top rate
  • An increase in the child tax credit from $2,000 to $2,500 through 2028
  • Ongoing debate regarding the state and local tax (SALT) deduction cap, with proposals to increase it from $10,000 to $30,000
  • Income tax exemptions for tips and overtime pay through 2028
  • Tax deductibility for auto loan interest through 2028
  • Creation of “money accounts for growth and advancement” (called “MAGA accounts”) for children under 8, usable for education, small business investments, and first-home purchases

For Businesses:

  • An increase in the pass-through business deduction from 20% to 23%, making it permanent
  • Reinstatement of 100% bonus depreciation for qualified business assets acquired between January 2025 and 2029
  • Restoration of research and development tax deductions

Notably, the proposal does not include previously anticipated provisions for a “millionaire tax” or changes to carried interest tax treatment. The proposal may also include raising the debt ceiling—the maximum amount the country can borrow—by approximately $4 trillion.

Budget shortfalls likely to continue expanding national debt

While the current proposal includes roughly $1.6 trillion in spending reductions through modifications to programs like Medicaid and nutrition assistance, these cuts are outweighed by tax reductions and spending increases in other areas.

Annual budget deficits contribute directly to the national debt, which has already surpassed $36 trillion—approximately $106,000 per American. Reports suggest the proposed budget could add an estimated $3 trillion or more to the debt over the coming decade. The most recent analysis by the nonpartisan Joint Committee on Taxation indicates the debt could grow by $3.7 trillion during this period.

The substantial growth of national debt in recent decades is well-documented, with interest payments continuing to climb. Since the majority of federal spending is directed toward mandatory programs like Social Security and Medicare, achieving meaningful spending reductions presents significant political challenges. This dynamic fuels concerns that tax rates may eventually need to increase to address the gap, even if the TCJA is extended or made permanent in the short term.

While deficit and debt levels remain important factors for long-term economic health, their immediate impact should be viewed in context. Markets have historically performed well across various levels of government debt and deficit spending. Paradoxically, some of the strongest market returns over the past two decades occurred following periods with the largest deficits, as these typically coincided with economic downturns when markets were already at low points. Consequently, making investment decisions primarily based on government spending patterns and deficits would likely have been counterproductive.

The bottom line? Moody’s downgrade of U.S. credit highlights growing concerns about America’s fiscal sustainability. The ongoing budget negotiations may further contribute to these challenges. However, historical patterns suggest investors are best served by maintaining their long-term investment strategies rather than reacting to fiscal headlines.

 

Investment Advisor Representative of Sanctuary Advisors, LLC. Advisory services offered through Sanctuary Advisors, LLC., a SEC Registered Investment Advisor. Tenet Wealth Partners is a DBA of Sanctuary Advisors, LLC.

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About The Author

Kevan Melchiorre, CFP®Co-Founder & Managing Partner

Kevan Melchiorre co-founded Tenet Wealth Partners in 2021 with a focus on delivering a premier client experience, supported by an innovative and fully integrated approach to wealth planning. As a CERTIFIED FINANCIAL PLANNER® practitioner with over 16 years of wealth management experience, Kevan partners with affluent individuals, families, and institutions to help align their capital […]

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