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U.S. credit warning? Who cares?

September 12, 2012: 8:00 AM ET

Moody's warned about a possible U.S. downgrade and the market shot up. What a difference a year makes.

FORTUNE – Moody's Investors Service on Tuesday warned it could downgrade the U.S. government's credit rating next year if steps aren't taken to deal with the rising debt.

The warning would ordinarily rattle markets, as investors worry that the nation's borrowing costs could soar. But the news is essentially not news at all. Investors responded by pushing the Dow up a half a percentage point to a 5-year high. And even if a downgrade actually happens, many economists predict the markets will likely snooze through it.

In its report, Moody's says the U.S. could lose its top notch Aaa rating if Congress repeals a slew of spending cuts and tax increases slated to kick in next year and fails to replace them with large-scale deficit-reduction measures. This comes as talks of a bipartisan deal to reduce the deficit have mostly stalled before the November elections.

Indeed, there are reasons to doubt that lawmakers will be able to avert the so-called 'fiscal cliff.' Last August, Congress raised the government's borrowing limit without agreeing to a significant deficit reduction package. Which, in turn, prompted Standard & Poor's to strip the U.S. of its stellar triple A rating, which fell one notch to AA+.

MORE: What the Fed should do (but probably won't)

Moody's (MCO) warning suggests doing something similar. The agency has warned of a downgrade since last year. Which is partly why markets have yawned. To be sure, the implications of the economy teetering over the fiscal cliff is indeed serious stuff – in July, the Congressional Budget Office warned that the mix of spending cuts and tax hikes could send the economy into a recession. But the implications of a downgrade from Moody's isn't much to fret.

Even when S&P announced its downgrade in July, 10-year Treasury yields didn't rise. They actually fell and are lower today than before the downgrade, according to a report by Capital Economics Tuesday. Ironically, investors thought Europe's ongoing debt crisis was rightfully worse, which has helped drive yields down to just below 1.5% in July from about 2.5% the same month last year.

Besides, if the Federal Reserves announces another round of bond buying, which some expect could come as soon as Thursday, yields could fall even lower.

Surely Moody's isn't the only agency considering downgrading the U.S. Fitch Ratings last year also sent out a warning. Despite the agencies' gloomier take on America's credit standing, though, yields likely won't jump. Capital Economics estimates they will actually stay close to 1.5% for "the next couple of years."

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About This Author
Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

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