Global Fixed Income Strategy - May 2025
US fiscal policy and the sustainability of government debt
The US economy has benefited from a fiscal boost since the pandemic, but adjustments may be needed going forward to maintain fiscal sustainability. As in other countries, the US government supported household and business cash flows during the pandemic but the US government was more generous than most other countries, leading to a build-up of excess savings in the US. The US continued to support the economy after the pandemic with initiatives such as the Inflation Reduction Act of 2022, aimed at addressing climate change, and the CHIPS and Science Act of 2022, aimed at boosting the domestic semiconductor industry, strengthening the nation’s technology ecosystem, and increasing the US share of global semiconductor manufacturing capacity.
The downside of these generous policies was the accumulation of government debt. The US Congressional Budget Office (CBO) estimates that the net government debt-to-GDP ratio was 98% at the end of 2024, while the gross debt-to-GDP ratio was 122%.1 These metrics have increased significantly in recent decades and rank high relative to other developed countries.2
The extension of the Tax Cuts and Jobs Act (Trump 2017 tax cuts), and potential additional tax cuts currently being discussed by the US administration, are likely to put upward pressure on the US fiscal deficit, which is already at an uncomfortably large level. Such concerns were highlighted by Moody’s’ downgrade of the US’s credit rating in May, citing large fiscal deficits and rising interest costs, and causing the US to lose its last triple-A rating.
In our view, Moody’s’ move is merely a symptom of a decline in the US’s fiscal health over the past several years and does not offer markets new information. Other rating agencies, including Standard and Poor’s in 2011, had already cut their US credit ratings to below triple-A. Consequently, the recent downgrade left little effect on markets after the initial shock value wore off. After the 2011 downgrade, most investment guidelines were rewritten to designate Treasuries as an eligible investment class generally, instead of specifically naming the triple A-rated bucket, meaning we would expect very limited forced selling as a result of Moody’s’ rating move. That being said, the reasons behind the downgrade – a large debt and debt service burden – are likely to be important going forward. Any news suggesting the need to increase Treasury issuance would likely drive Treasury yields higher and the yield curve steeper.
We discount hyperbolic comments about a US default, though there are refinancing risks looming – approximately USD8 trillion in Treasury notes and bonds are set to mature by the end of 2027.3 Concerns that the Trump administration’s fiscal framework could mean larger deficits raises fears around debt sustainability, which could put upward pressure on longer-term US Treasury yields. Tensions around raising the debt ceiling could also put pressure on US Treasuries during the period of negotiation. We have full confidence that the US debt limit will be raised, but the federal government’s cash and extraordinary measures will likely be exhausted sometime in August and markets have already started to price US debt risks around that time.
Investment risks
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
Non-investment grade bonds, also called high yield bonds or junk bonds, pay higher yields but also carry more risk and a lower credit rating than an investment grade bond.
Mortgage- and asset-backed securities, which are subject to call (prepayment) risk, reinvestment risk and extension risk. These securities are also susceptible to an unexpectedly high rate of defaults on the mortgages held by a mortgage pool, which may adversely affect their value. The risk of such defaults depends on the quality of the mortgages underlying such security, the credit quality of its issuer or guarantor, and the nature and structure of its credit support.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
