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MACROECONOMIC PERSPECTIVES: A Credit Downgrade

TW-WA ARTICLE

What’s in a Rating?

In May, Moody’s downgraded the U.S. credit rating from the topA aa to Aa1. This move by one of the major credit rating agencies—S&P and Fitch are the other two—raised the question: Does a downgrade matter?

First, what is a rating? A credit rating assesses a borrower’s ability and willingness to repay debt. Unlike personal credit scores, which typically range from 300 to 900, government credit ratings are expressed as letter grades, with AAA representing the highest quality and lowest risk. A downgrade implies an increasing likelihood that a government may default on its bonds.

Why does this matter? A downgrade generally means investors demand higher interest rates to compensate for added risk. Higher interest payments raise the cost of government borrowing. To sustain spending, more bonds must be issued—further increasing the debt burden. In the U.S., interest payments have become the second-largest federal expense, surpassing defence spending in 2024.

While credit downgrades can shake investor confidence, equity markets had a muted response, briefly jittering. This was partly because the move wasn’t a surprise, lagging similar downgrades by Fitch in2 023 and S&P in 2011. However, bond prices have come under pressure, sending yields higher, with the 30-year rate surpassing 5 percent in May. It comes at a time when a Republican tax bill rekindled debate about the sustainability of the U.S. deficit and spending.

There are likely to be ripple effects. A surge in U.S. mortgage rates may dampen consumer spending. Credit card and auto loan rates are less likely to be affected, as they tend to follow the federal funds rate more directly.

Why is this significant for Canada? Canada is among the few nations still holding the top credit rating from at least two major agencies. Fitch downgraded Canada in 2020 due to pandemic-related spending. While Canada’s credit outlook remains stable, a downgrade would be unwelcome. Net debt is not out of step with other AAA rated economies, but gross debt levels are high, and rising interest rates would raise debt-servicing costs—straining future budgets. The heightened focus on global debt may help explain why Prime Minister Carney has opted to delay the release of the federal budget, usually delivered in the spring. Credit agencies continue to evaluate sovereign debt positions, and the U.S. downgrade follows a move by Moody’s’ to downgrade France at the end of 2024.

The information contained herein has been provided for information purposes only. The information has been drawn from sources believed to be reliable. Graphs, charts and other numbers are used for illustrative purposes only and do not reflect future values or future performance of any investment. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance. This does not constitute a recommendation or solicitation to buy or sell securities of any kind. Market conditions may change which may impact the information contained in this document. Wellington-Altus Financial Inc. (Wellington-Altus) is the parent company to Wellington-Altus Private Wealth Inc. (WAPW), Wellington-Altus Private Counsel Inc. (WAPC), Wellington-Altus Insurance Inc. (WAII), Wellington-Altus Group Solutions Inc. (WAGS), and Wellington-Altus USA Inc. Wellington-Altus (WA) does not guarantee the accuracy or completeness of the information contained herein, nor does WA assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Before acting on any of the above, please contact your financial advisor..

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The opinions contained herein are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Wellington-Altus Private Wealth. Assumptions, opinions and information constitute the author’s judgement as of the date this material and subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Graphs and charts are used for illustrative purposes only and do not reflect future values or future performance of any investment. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance. All third party products and services referred to or advertised in this presentation are sold by the company or organization named. While these products or services may serve as valuable aids to the independent investor, WAPW does not specifically endorse any of these products or services. The third party products and services referred to, or advertised in this presentation, are available as a convenience to its customers only, and WAPW is not liable for any claims, losses or damages however arising out of any purchase or use of third party products or services. All insurance products and services are offered by life licensed advisors of Wellington-Altus.