The real crisis was never tariffs – it’s US debt

Perhaps it is all too easy to see with hindsight, but the tariff hullaballoo was only ever a distraction.

Now that the Taco trade (Trump Always Chickens Out) is firmly in place and markets have enjoyed a rapid if wobbly resurgence, the eyes of the world’s investors have moved to the topic that was always going to be of more material importance for the global economy: the increasingly shaky outlook for US government debt.

Two announcements over the past weekend have raised the issue to one of critical importance. 

The first was the news on Friday evening that ratings agency Moody’s has stripped the world’s largest economy of its vaunted triple-A credit rating. The agency on Friday afternoon cut its credit rating on the US by one notch to Aa1 from Aaa, warning about rising levels of government debt and a widening budget deficit. Fitch and S&P, the other main agencies, had previously removed the US’s pristine rating.

 “While we recognise the US’s significant economic and financial strengths, we believe these no longer fully counterbalance the decline in fiscal metrics,” Moody’s said on Friday afternoon. The ratings agency expects federal deficits to widen to an eye-watering 9% of GDP by 2035, up from 6.4% last year, largely due to increased interest payments on debt, entitlement spending and “relatively low revenue generation”.

Predictably, the White House responded not by addressing the substance of the warning, but by shooting the messenger.

Trump’s spokesman Steven Cheung dismissed the downgrade and lashed out at Mark Zandi, Moody’s chief economist. “Nobody takes his ‘analysis’ seriously. He has been proven wrong time and time again.” Zandi was notably not an author of this report and works for Moody’s Analytics, a separate part of the company that is not part of its ratings business.

But markets did take the downgrade seriously. On Monday, following the downgrade, the dollar sold off against all other major currencies and long-term US government debt yields rose above the critical 5% level (bond yields move inversely to prices), their highest since 7 April when Trump’s tariffs triggered a global sell-off of US assets. Rising Treasury yields will further complicate the government’s ability to cut back spending by running up its interest payments, while also threatening to weaken the economy by forcing up rates on loans such as mortgages and credit cards.

Second, on Sunday, the next fiscal alarm bell rang. A key congressional committee approved the Trump administration’s proposed 2025 budget, dubbed the “Big Beautiful Bill” by the US president. The legislation includes hundreds of billions of dollars in tax cuts without corresponding spending reductions, which analysts expect will further balloon the deficit.

The Bill had briefly stalled on Friday when five Republican lawmakers voted against it, but it narrowly cleared the committee after Trump publicly pressured his party. “Republicans MUST UNITE behind, ‘THE ONE, BIG BEAUTIFUL BILL!’” he wrote on social media on Friday. “We don’t need ‘GRANDSTANDERS’ in the Republican Party. STOP TALKING, AND GET IT DONE!” 

Big is one way of describing the budget. Reckless and irresponsible might be another. The US has been running wartime-level deficits since the pandemic, while at full employment. Current and forecast spending is simply well above levels economists view as sustainable, and the market is reacting. “The Bill is driving up the long end,” said Subadra Rajappa, head of US rates strategy at Société Générale, referring to the jump in long-dated bond yields.

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