The move dealt a blow to markets, which had enjoyed a healthy run-up last week after Washington and China hammered out a deal to temporarily slash tit-for-tat tariffs, dialling down the tensions in a painful trade war between the superpowers.
After the rout sparked by US President Donald Trump's Liberation Day tariffs bazooka, investors have in recent weeks raced back to buy up beaten-down stocks as the White House tempered its hardball tariff approach and then announced the agreement with China.
But selling pressure returned Monday after Moody's cut its rating on US debt to Aa1 from Aaa, noting "the increase over more than a decade in government debt and interest payment ratios to levels that are significantly higher than similarly rated sovereigns".
It added that it expected federal deficits to widen to almost nine percent of economic output by 2035, up from 6.4 percent last year, "driven mainly by increased interest payments on debt, rising entitlement spending, and relatively low revenue generation".
Analysts said the cut in the gold standard rating -- which follows S&P in 2011 and Fitch in 2023 -- could indicate investors will want higher yields on Treasuries, pushing up the cost of government debt.
Still, Treasury Secretary Scott Bessent dismissed the announcement, saying it was "a lagging indicator" and blaming Trump's predecessor Joe Biden.
"We didn't get here in the past 100 days," he told CNN. "It's the Biden administration and the spending that we have seen over the past four years that we inherited, 6.7 percent deficit-to-GDP, the highest when we weren't in a recession, not in a war."
And White House communications director Steven Cheung hit out at Moody's Analytics on X, singling out its chief economist Mark Zandi.
"Nobody takes his 'analysis' seriously. He has been proven wrong time and time again," Cheung posted.
The news added to a frustrating time for the US president after Congress failed to pass his "big, beautiful bill" to extend tax cuts passed in his first term and impose new restrictions on welfare programmes.
Independent congressional analysts say the package would add more than $4.8 trillion to the federal deficit over the coming decade.
The bill came up short in a key vote owing to opposition from several Republican fiscal hawks.
Republican congressman French Hill, who chairs the House Financial Services Committee, said the downgrade "is a strong reminder that our nation's fiscal house is not in order".
House Speaker Mike Johnson told "Fox News Sunday" that he plans for a floor vote on the package by the end of the week.
Equities in Hong Kong and Shanghai fell as below-forecast Chinese retail sales figures reinforced the view that the world's number two economy continues to struggle even after officials unveiled fresh stimulus measures. However, factory output picked up more than expected.
Tokyo, Sydney, Seoul, Singapore, Wellington, Taipei and Jakarta all fell, while US futures were also well down.
The dollar was also down against its peers.
Gold recovered some recent losses owing to its safe haven appeal, rising to $3,225 per ounce.
Still, National Australia Bank's Ray Attrill said: "Moody's actions will have zero impact on any investor's ability or willingness to continue holding US Treasuries -- that would likely require downgrades of four or five more notches."
And SPI Asset Management's Stephen Innes said investors would be more interested in upcoming data that would provide a better idea about the state of the world's top economy.
"Moody's may have dropped the mic, but for equity traders, the real test this week will be Main Street," he wrote in a note.
"We're heading into a make-or-break retail earnings slate -- Target, Home Depot, Lowe's, TJX, Ralph Lauren all report -- and this is where tariff theory collides with checkout-line reality.
"Yes, the S&P has clawed back 18 percent since the 'Liberation Day' tariff blitz, but the consumer has been the market's unsung hero. Now they're about to be audited."
He said the "downgrade is more psychological than mechanical".
- Key figures at around 0230 GMT -
Tokyo - Nikkei 225: DOWN 0.4 percent at 37,617.63(break)
Hong Kong - Hang Seng Index: DOWN 0.6 percent at 23,211.29
Shanghai - Composite: DOWN 0.2 percent at 3,361.55
Euro/dollar: UP at $1.1180 from $1.1154 on Friday
Pound/dollar: UP at $1.3300 from $1.3278
Dollar/yen: DOWN at 145.09 yen from 145.92 yen
Euro/pound: UP at 84.05 from 83.97 pence
West Texas Intermediate: DOWN 0.1 percent at $62.41 per barrel
Brent North Sea Crude: DOWN 0.2 percent at $65.27 per barrel
New York - Dow: UP 0.8 percent at 42,654.74 (close)
London - FTSE 100: UP 0.6 percent at 8,684.56 (close)
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