How the Moody's Downgrade and Rising Deficits Impact Investment Strategy

The U.S. has officially lost its perfect credit rating—again. Moody’s recently downgraded the country’s debt from Aaa to Aa1, following in the footsteps of Fitch (2023) and S&P (way back in 2011). This latest move comes at a time when lawmakers are debating a new budget proposal that could further widen the deficit, even as they talk about cutting taxes. It’s a messy mix of rising debt, political gridlock, and long-term uncertainty. Understandably, many investors are wondering: What does this mean for the markets—and for our own investment strategies?

Over the past 15 years, we’ve seen plenty of drama out of Washington when it comes to the budget and debt ceiling—and markets have definitely felt it. From the 2011 debt downgrade by S&P, to the 2013 fiscal cliff, and the government shutdowns in 2018 and 2019, each of these events stirred up volatility and uncertainty. Yet in every case, lawmakers ultimately reached a deal, and markets found their footing again.

After the headline-grabbing downgrade in 2011, the S&P 500 dropped sharply—but fully recovered just a few months later. And interestingly, despite these kinds of downgrades, U.S. Treasuries continue to be the go-to safe haven when markets are under stress. They still play a key role in providing global financial stability.

So when it comes to concerns over the national debt and the ongoing budget battles in Washington, keeping things in perspective is key. From a citizen and taxpayer standpoint, it’s completely reasonable to feel uneasy about the country's long-term fiscal path. But unfortunately, there are no easy answers—many well-intentioned reform efforts over the years have failed to rein in deficits in a meaningful way.

That said, it’s just as important not to overreact with your investments. History shows that while these political standoffs can cause short-term market swings, markets tend to recover and move forward over time. Staying focused on your long-term goals, maintaining a diversified portfolio, and tuning out the noise from D.C. remains one of the most effective strategies for building lasting wealth.

Moody’s recent downgrade serves as another reminder of the challenges ahead, especially as attention shifts from trade policy to fiscal policy. While markets rallied after the last election in part due to optimism around pro-growth policies and a possible extension of the 2017 tax cuts, Moody’s made it clear that ballooning deficits and rising interest costs remain a major concern. Their view? Neither side of the aisle is likely to pass the kind of long-term spending reforms needed to reverse course anytime soon

Tax cuts are likely to be extended

At the same time as Moody’s downgrade, Congress is working on a new budget proposal—one that’s still taking shape, but already includes some noteworthy tax changes. A key goal of the plan is to avoid the so-called “tax cliff” at the end of 2025, when the individual tax cuts from the 2017 Tax Cuts and Jobs Act (TCJA) are set to expire. By addressing this in advance, lawmakers are aiming to give households and businesses more stability and certainty..

Here’s a look at some of the major provisions currently being considered (though it’s worth noting that these could still change):

For Individuals:

• Make TCJA individual tax brackets permanent, keeping the top rate at 37%

• Expand the child tax credit from $2,000 to $2,500 through 2028

• Raise the cap on the state and local tax (SALT) deduction to $30,000 (currently $10,000)

• Exempt tips and overtime pay from income taxes through 2028

• Allow auto loan interest to be tax-deductible through 2028

• Introduce “MAGA” accounts—special savings vehicles for kids under 8 that can be used for education, starting a business, or buying a first home

For Business Owners:

• Increase the pass-through business income deduction from 20% to 23% and make it permanent

• Restore full bonus depreciation for business assets acquired between 2025 and 2029

• Reinstate the full deduction for research and development expenses

Some high-profile items are notably absent, including any tax hikes for high earners or changes to how carried interest is taxed. The debt ceiling may also be raised by another $4 trillion under this proposal—meaning the national debt will likely continue to grow.

While these proposals aim to provide tax relief and long-term certainty, they also raise important questions about future fiscal sustainability. As always, it’s wise to keep an eye on the changes—but not to let them drive your investment decisions. Staying focused on long-term goals, rather than reacting to headlines, continues to be the best strategy.

The national debt will likely keep growing

While the latest budget proposal includes some spending cuts, the tax reductions are significantly larger—meaning the government is still on track to spend more than it brings in each year. These annual deficits continue to add to the national debt, which has already surpassed $36 trillion.

If passed as-is, the budget could add another $3 trillion or more to the debt over the next decade. Much of federal spending goes toward programs like Social Security and Medicare—areas that are politically tough to cut—so many economists are raising the possibility that tax rates may eventually need to rise.

That said, history reminds us that markets don’t move in lockstep with government debt. In fact, some of the strongest stock market returns have followed periods of the largest deficits—usually during or after a crisis when valuations were low. Trying to time investments based on government spending patterns has generally been a losing strategy.

The bottom line? While the U.S. credit rating downgrade reflects legitimate concerns about America's long-term fiscal path, and current budget negotiations may compound these challenges, historical evidence supports maintaining investment discipline and adhering to long-term financial strategies as the most effective approach for navigating these uncertainties.

As always, contact us with any questions or if you would like to dive into our market outlook further!

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