By Nicole Goodkind
Moody's downgrade of the U.S. credit rating could have implications for prices that Federal Reserve policymakers will need to monitor, said Federal Reserve Bank of Atlanta President Raphael Bostic on Monday.
"My view is we have to see how this plays out," Bostic said at the Atlanta Fed's financial markets conference in Amelia Island, Florida. The comments followed Moody's move late last week to cut its rating on U.S. debt from Aaa to Aa1 status, citing rising budget deficits and political dysfunction in Washington.
"These things will potentially have implications on prices down the road that we're going to have to pay attention to," Bostic said.
Moody's now expects the U.S. federal deficit to rise to nearly 9% of gross domestic product this year, up from 6.4% in 2024. The downgrade raises questions about the U.S.'s ability to handle its spending and debt over the long term.
"It's critical that the public understand that years of Congress and executive branch dysfunction will now result in anything financed in both the public and private sector being more expensive," Joe Brusuelas, chief economist at RSM US, wrote in a note.
That is because concern about the U.S.'s financial strength could prompt investors to demand higher yields when they lend to the government by buying Treasury debt. Those yields are the primary factor determining the cost of mortgages and other loans for both consumers and businesses.
Yields on the 10-year Treasury note remained close to 4.5% on Monday afternoon, about where they were a year ago. As Barron's Brian Swint pointed out, the downgrade is largely symbolic because Moody's was the last of the big three credit-rating firms to act. But it adds to an already complex policy environment.
If yields were to rise materially again, that could influence the Fed's thinking on interest rates. Bostic, who isn't a voting member of the Federal Open Market Committee this year, told CNBC on Monday he is now "leaning" toward just one rate cut in 2025.
On May 12, the White House announced a 90-day suspension of the sky-high tariffs that were choking off trade between China and the U.S., an easing that was well received by markets. But that hasn't changed his outlook, Bostic said.
Even with the pause, the "Liberation Day" tariffs Trump unveiled on April 2 are working their way through the economy. Based on April inflation data, the average effective tariff rate is now 16%, up from 3% in February, according to Sam Tombs of Pantheon Macroeconomics.
Market expectations have moved as well. The CME FedWatch Tool currently shows interest-rate futures are pricing in two quarter-point cuts this fall, down from the three cuts that markets anticipated earlier in the year. That is roughly in line with the Fed's March projections, which pointed to two cuts this year and two more next year.
Federal Reserve Gov. Philip Jefferson also addressed the downgrade at the conference on Monday. He said that the Fed would "put that downgrade in the same perspective that we do with all incoming information."
"Financial markets are changing a great deal. It's important to stay focused on our mission," he added, referring to the Fed's dual mandate of price stability and full employment.
Both Jefferson and Bostic spoke of continuing uncertainty facing the U.S. economy. "There's just so much uncertainty. I just think about all [the economic headwinds] that we face right now, and it's all moving at the same time in ways that are not always consistent with historical experience. That's a big challenge," Bostic said.
"I talk to analysts and people in the marketplace, and there are very different probabilities attached to the likelihood of significant economic weakness. And that wide range says that it is very hard to assign probabilities on what an actual move forward would look like," he added.
Jefferson noted that while there are higher-than-normal risks of both higher inflation and lower employment, the central bank remains in a "good place" to stay patient and assess incoming data.
It is too early to tell how tariffs and other White House policies regarding immigration and deregulation, as well as its proposed tax changes, will affect the Fed's dual mandate. "But we'll find out sooner or later," said Bostic.
Minneapolis Federal Reserve Bank President Neel Kashkari, meanwhile, said Monday afternoon that the downgrade raises "a question mark" about American competitiveness. It raises the question, he said, of "what is the U.S.'s long term competitive position going to be relative to other advanced economies around the world?"
Consumer sentiment, meanwhile, continues to soften. The University of Michigan's preliminary May release showed sentiment falling to its second-lowest level on record. Yet hard economic indicators remain relatively strong, a disconnect that has led some analysts to refer to the current environment as a "vibecession."
"The split between bad vibes and good data has gone on for years now, leading me to wonder, especially given the rise in partisanship as a driver of the movements in sentiment surveys, if these surveys have much real economic content," wrote Jared Bernstein, former chair of the White House Council of Economic Advisers, in a research note.
Some see the temporary easing in U.S.-China trade tensions as a modest positive. "De-escalation shifts risks in the direction of a little more growth and a little less inflation, and keeps the unemployment rate near current levels," Morgan Stanley's Vishwanath Tirupattur and Michael Gapen wrote Sunday.
The Fed next meets June 17--18 and is widely expected to hold interest rates steady for a fourth straight meeting. Policymakers will also update their Summary of Economic Projections, offering fresh guidance on the likely path of inflation, employment, and interest rates.
Write to Nicole Goodkind at nicole.goodkind@barrons.com
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(END) Dow Jones Newswires
May 19, 2025 14:29 ET (18:29 GMT)
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