Attack the Week (ATW)

May 18, 2025

Sunday Thoughts

Rating agencies are useless. I always thought that way and never really changed my mind. How can for-profit companies not be regarded as having a conflict of interest when taking money from issuers and rating them? This never made sense to me. Still, we rely on them to give creditors an alphabet soup of letters to determine their creditworthiness.

Having worked in the industry over the financial crisis years, I can tell you numerous instances when corporate or sovereign news happened just for rating agencies to downgrade them after the markets had already moved. Their insights are of no use when managing money.

Reading fintwit takes after Moody’s downgraded US debt had me shaking my head. Should we be surprised? Are the fiscal worries in US Treasuries not already known to market participants?

In last Friday's Chart Book, I wrote about my narrow focus: firmly observing the behaviour of the US yield curve, especially on long-dated US treasuries. This downgrade won’t change that and affirms that this theme is developing.

I would be very surprised if markets react dramatically to this news. Past behaviours are irrelevant in assessing what is likely ahead. Market structures are different, and we are finding ourselves in a completely different regime. US debt and its sustainability are rightly questioned, as fiscal consolidation looks unlikely. As markets have been overly focused on more positive tariff news, this theme could now take centre stage, however. As such, I am looking forward to observing how various markets react over the coming week.

Source: Dall-E

US debt has no credit risk attached to it — not in an operational sense — because the federal government issues debt in a currency it controls, the US dollar. As the sovereign issuer, it can always meet its nominal obligations by creating more dollars if necessary. This means the risk of a technical inability to pay is essentially zero. However, credit risk can still arise from political dysfunction, such as debt ceiling standoffs or legislative gridlock, where policymakers may delay or even refuse payment due to ideological disputes rather than financial constraints. These scenarios don’t reflect insolvency, but rather a self-imposed default risk, rooted in governance rather than economics. Investors, therefore, must assess not just monetary mechanics but also the political reliability of the issuer.

The market is correct to be uneasy about the government’s credibility and fiscal prudence. There is no free lunch, and bond markets will punish you. Trump and his team might be able to smooth-talk equity markets, but bond markets won’t take any nonsense, but hard action. Trump might have to find out that making deals with bond markets isn’t about bullshit. He might be facing one of his hardest tests yet.

Let’s now read Macro D’s latest thinking before briefly scanning the week’s upcoming calendar. We then revisit some charts, which give us some interesting setups. As always, we conclude with a review of the output from our asset allocation model.

Let’s go!