Longer-dated bonds hit as Moody's cuts AAA rating

The yield on 30-year Treasury bonds hit its highest this year on Monday, after the United States lost its remaining AAA-credit rating from a major ratings agency, delivering a stark reminder to investors about the resilience of U.S. government finances.

Moody's Investors Service on Friday cut its credit rating for the world's largest economy by a notch to "Aa1" from "Aaa", citing large fiscal deficits and growing interest costs.

The cut itself was not much of a surprise to investors, given rivals Fitch and S&P Global downgraded the United States years ago. Yet the knock to sentiment was palpable across markets, as Treasury yields rose and the dollar and stock index futures fell.

Adding to the concern was U.S. President Donald Trump's sweeping tax-cut bill that won approval from a key congressional committee on Sunday to advance towards possible passage in the House of Representatives later this week.

Nonpartisan analysts say the bill could potentially add $3 trillion to $5 trillion to the nation's ballooning $36.2 trillion debt pile over the next decade.

The yield on 30-year Treasury bonds (US30YT=RR) jumped by more than 12 basis points to a high of 5.2%, its highest for the year. It was set for its biggest one-day increase since the turmoil unleashed across the bond markets back in April by Trump's initial tariff announcement.

"Confidence has been shaken (in U.S. markets) and it is going to take some time for that to return and that's going to leave participants jumping at shadows a little bit," said Tony Sycamore, market analyst at IG.

"The reaction has been getting back to concerning levels for the 30-year yield and certainly that long end is showing some signs of distress," Sycamore said.

Investor confidence in U.S. financial assets has been steadily eroding this year as Trump's erratic and aggressive trade policies stoke recession fears and shake longstanding faith in the dollar.

CONFIDENCE HIT

Yields on 10-year Treasuries US10Y were up about 11 bps at 4.55%, while shorter-dated 2-year notes (US2YT=RR) were broadly muted.

The cost of insuring against a U.S. sovereign default - which investors and credit ratings agencies alike agree is off the table - edged up on Monday.

Five-year credit default swaps, which bondholders use to hedge against default risk, rose to 55 bps, from 54 bps on Friday, according to S&P Global Market Intelligence. This was their highest for a week.

The spike in yields, which ordinarily would prop up the dollar, pulled the U.S. currency lower against the likes of the euro, yen and Swiss franc. Futures on the benchmark S&P 500 ES1! and the tech-heavy Nasdaq NQ1! dropped more than 1%.

HSBC analysts said the outlook for the dollar largely hinges on how Treasuries react to the fiscal situation and ongoing budget debate.

"The best outcome for the U.S. dollar might be stability in the fiscal backdrop, with market-friendly tax cuts paid for through targeted spending cuts," they wrote.

They warned of a "triple threat" scenario, where U.S. yields rise, equities fall and the dollar weakens.

Analysts at Mirabaud Equity Research said the downgrade was not a serious technical development as most banks, clearing houses and money market funds still treated Treasuries as if they were triple-A rated and capital requirements or margin calls would not change.

"But symbolically? It's an earthquake. When the last bastion of credibility falls, it's not the financial mechanism that fails...it's confidence. And if the markets pretend to ignore it today, they could pay a higher price tomorrow, because the dynamics of the revaluation of sovereign risk never warn you when they get out of control."