Moody’s reminds Asia of risks of being Washington’s banker
TOKYO — If Pan Gongsheng gets tired of central banking, the People’s Bank of China governor may have a future in hedge fund management.
In March, before the April chaos in US debt markets and last week’s US credit downgrade, Pan’s PBOC and the State Administration of Foreign Exchange (SAFE) displayed impeccable market timing, quietly reducing Beijing’s leverage to the dollar.
So much so that Beijing is now only the No 3 holder of US Treasuries, leaving the dubious No 2 honor to the UK.
As recently as 2019, China was the top financier of Washington’s fiscal imbalances. Japan is now on the hook for the most — US$1.1 trillion. The trouble for China, of course, is that it still has $765.4 billion of exposure to a dollar that’s as vulnerable to collapse as it’s been in decades.
US Treasury Secretary Scott Bessent’s impulse to dismiss Washington losing its last AAA rating and push ahead with the very policies behind the move may invite more downgrades — and even greater trouble for the dollar.
Bessent’s boss, US President Donald Trump, doesn’t get all the blame for Moody’s Investors Service revoking the pristine rating it first gave the US in 1919. It takes more than one presidency to run up a national debt approaching $37 trillion.
But the negligence and tone deafness toward basic economic reality leaves little question why Moody’s acted now, on Trump 2.0’s watch.
Bessent’s we-wouldn’t-have-done-anything-differently tone in Sunday talk show appearances explains why.
Many of the giant tariffs that cratered the stock market, reanimated the “bond vigilantes”, and sent the dollar sharply lower are still with us. Traders can rejoice at Trump’s lowering China taxes to 30% from 145%. But it’s still at levels seen in the 1930s, when the Smoot-Hawley Tariff Act deepened the Great Depression.
Markets can think Trump learned his lesson from acting so erratically — and losing virtually all of America’s top allies in just four months — or admit the obvious. Many investors worry the answer is absolutely not.
Investors are free to hope that Trump isn’t planning to fire Federal Reserve Chair Jerome Powell. Or to push for a weaker dollar, either unilaterally or via some “Mar-a-Lago accord” that sends the yuan shapely higher. Here, too, many investors fear he will.
Folks can hope that Trump and Xi will soon sit down for “grand bargain” talks between the Group of Two nations. Yet Chinese leader Xi Jinping isn’t the caving type. Has Beijing offered Trump the slightest concession on access to China Inc. so far? Odds are, many economists worry, the Trumpian fireworks will resume.
Finally, it’s unclear whether Moody’s got Trump World’s attention in the right way. Any other US administration would internalize why Moody’s cut Washington to Aa1 the way S&P Global and Fitch Ratings did in years past.
Not according to Bessent’s take. “I don’t put much credence in the Moody’s” downgrade, Bessent told CNN. He stressed that the tax-cut bill being debated in Congress remains on track. And that it would spur economic growth that generates more than enough revenue to pay down US debt.
It’s an unwelcome reminder — and poorly timed one — that Trump’s 1985 mindset is colliding with the global realities of 2025. As Washington gives “trickle-down economics” another try, its credit rating hangs in the balance.
So does trust in the dollar. Bessent calling credit ratings a “lagging indicator” isn’t the witty argument he thinks. Not at all moment when the Republican Party is pushing a budget package — Trump’s so-called “big, beautiful bill” — that will add trillions to the federal deficit. Estimates are US$4 trillion over the next decade added to the federal primary deficit, excluding interest payments sure to skyrocket.
For now, some market participants are siding with Bessent.
“Most are dismissing the news as not a big deal, and perhaps it’s not,” says Michael Kramer, founder of Mott Capital. “After all, the US has already had two prior downgrades.”
Yet there’s no arguing that the timing of all this could hardly be worse. “The key issue,” Kramer says, “is that this downgrade comes at a moment when term premiums were already rising, potentially adding even more upward pressure.”
As such, notes Tracy Chen, a portfolio manager at Brandywine Global Investment Management, it remains to be seen whether the market reacts differently as the “haven nature of Treasury and the US dollar might be somewhat uncertain” now.
But the dollar’s troubles go much deeper than that. The euro’s rally in recent weeks has global markets buzzing about viable dollar alternatives.
European Central Bank President Christine Lagarde said the recent rise of the euro against the dollar is a consequence of US President Donald Trump’s erratic policies and an opportunity for Europe.
“It’s impressive to note that in a period of uncertainty when we should normally have seen the dollar appreciate significantly, the opposite happened: the euro appreciated against the dollar,” Lagarde told La Tribune Dimanche newspaper. “It’s counterintuitive, but justified by the uncertainty and loss of confidence in US policies among certain segments of the financial markets.”
One big worry is that US inflation remains stubbornly high as gross domestic product shrinks. Stagflation risks may be riding in real time as Trump’s tariffs hit US households.
“Even if a mild recession takes hold, a higher inflation outcome seems assured given the addition of tariffs to the trajectory of ever bigger budget deficits,” says Steve Blitz, managing director at TS Lombard. “Monetary policy alone cannot reverse the trend without the deficit shrinking.”
Jeffrey Roach, chief economist for LPL Financial, adds that “the uncertainty about what might happen after these temporary trade deals makes things difficult for the Fed since stagflation remains a risk. If the fog does not clear, the Fed might not be able to adjust policy in June.”
In other words, Trump’s climbdown on tariffs might’ve been too little, too late.
“Even though tariff fears have calmed, more time is needed to see how the existing tariffs take shape and affect inflation and the economy,” says Skyler Weinand, chief investment officer at Regan Capital. “Unless we start to see unemployment rise significantly, the Fed is likely to keep rates unchanged for the next six months.”
Analysts at JPMorgan Chase & Co point to a Moody’s report from 2023, when the ratings company shifted its US outlook to negative.
On Friday, Moody’s said US governments have consistently “failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs.” In 2023, it warned that this moment would likely come.
But it’s an open question whether Moody’s is about to revive another 2023 opinion that got lots of attention. At the time, Moody’s argued the dollar’s place at the center of the global trading system was safe.
As Moody’s wrote in May 2023: “We expect a more multipolar currency system to emerge over the next few decades, but it will be led by the greenback because its challengers will struggle to replicate its scale, safety and convertibility in full.”
Yet, it warned then that increased US protectionism, weaker government institutions and concerns about a default would imperil the dollar’s global dominance.
“The greatest near-term danger to the dollar’s position stems from the risk of confidence-sapping policy mistakes by the US authorities themselves, like a US default on its debt, for example,” Moody’s warned two years ago. “Weakening institutions and a political pivot to protectionism threaten the dollar’s global role.”
It hardly helps that Trump’s inner circle has, at times, flirted with the idea of limited defaults to gain leverage over trading partners.
Another big risk is the collision course between Trump and Powell. In a social media rant over the weekend, Trump wrote: “THE CONSENSUS OF ALMOST EVERYBODY IS THAT, ‘THE FED SHOULD CUT RATES SOONER, RATHER THAN LATER.’” He added that “Too Late Powell, a man legendary for being Too Late, will probably blow it again – But who knows???”
TS Lombard’s Blitz says that “one can, in fact, imagine a scenario where the Fed helps the dollar strengthen to keep in check the real interest rates needed to sustain needed inflows and all that, in turn, overwhelms the tariffs as a barrier to keep firms from sourcing foreign capital and labor.”
This, however, would enrage Trump, upping the odds that he tries to fire Powell. Herein lies one of the top risks to US Treasuries and the dollar.
This fragility of US Treasuries is imparting a unique leverage point for the Bank of Japan, PBOC and other top Asian monetary authorities. Asia’s main leverage over Washington right now is bonds, currencies and in services trade. This latter piece refers to America’s deep dependence on Asian markets for financial services, technology, and intellectual property.
The mechanics of Trump’s trade war suggest an imperfect understanding of the US economy’s Asia-related vulnerabilities. And poor situational awareness, as China and the Global South join forces to find an alternative to the dollar.
Bond traders, the type that take matters into their own hands when a government’s policy mix seems out of whack, will almost certainly pounce with growing ferociousness.
That puts an even bigger target on US Treasuries and the dollar as 2025 unfolds. And it might have hedge fund recruiters Googling when Pan’s term at PBoC ends.
Follow William Pesek on X at @WilliamPesek
