What Happens When the U.S. Loses Its Last AAA Rating? Sell America Again or Just “Sell the Fact”?

TradingKey - Following news that Moody’s downgraded the U.S. sovereign credit rating, and that China’s holdings of U.S. Treasuries fell to third place globally, Wall Street is now weighing a critical question: Will investors "sell the fact" and return to dollar assets — or will this trigger another triple selloff across stocks, bonds, and the U.S. dollar?

On Friday, May 16, after U.S. markets closed, Moody’s announced it had downgraded the United States’ sovereign credit rating from Aaa to Aa1, citing concerns that the country’s large fiscal deficits could further deteriorate its financial health. This move effectively means the U.S. has now lost its last AAA rating from a major global rating agency.

Adding to the pressure, on the same day, the U.S. Treasury released new data showing that China reduced its U.S. Treasury holdings in March, marking the first time since the beginning of the century that China held fewer U.S. bonds than the United Kingdom. 

Just weeks after the market was rattled by the April Treasury selloff and the triple sell-off in stocks, bonds, and the dollar, a fresh wave of concern is emerging — highlighting a fundamental issue: waning confidence in dollar-denominated assets.

An economist at Nomura Research Institute noted that after Moody’s downgrade, it may be necessary to consider the possibility of another round of broad-based market declines across equities, fixed income, and the U.S. currency.

On Monday, May 19, during Asian trading hours, the DXY U.S. Dollar Index fell 0.73% to 100.35, while the yield on the 10-year U.S. Treasury rose from around 4.4% to 4.524%. In pre-market trading, S&P 500 futures were down over 1%, and Nasdaq 100 futures fell nearly 2% .

Some Argue the Impact Could Be Limited

However, some analysts believe the impact of Moody’s downgrade may be limited.

Barclays pointed out that since Standard & Poor’s downgrade of the U.S. in 2011, changes to the U.S. government’s credit rating have largely lost their political and market significance, with any resulting market reaction being minimal at best.

Wall Street had also anticipated such a downgrade for some time. Analysts at Franklin Templeton Investment Solutions noted that a downgrade was not surprising, given the accelerating pace of fiscally unsustainable stimulus spending without adequate revenue backing.

As for China’s reduction in U.S. Treasury holdings, some observers argue this reflects a long-term diversification strategy in managing foreign exchange reserves — rather than a sign of broader weakness in global demand for U.S. debt.

So far, there has been no significant decline in overall foreign demand for U.S. Treasuries.