Macro views

Why deficits impact interest rates, credit ratings

July 10, 2025 - 3 min

Chief Executive Officer, Chief Investment Officer, and Portfolio Manager – Gateway Investment Advisers, LLC

Gateway market perspective

Market volatility experts from Gateway Investment Advisers, specialists in options-based investment strategies, examine key volatility trends and risk management ideas each month to help investors stay invested for the long run.

Dominating deficits:

“Fiscal dominance” is when US deficits are so large they render the Federal Reserve’s (Fed's) monetary policy ineffective.
On May 16, Moody’s downgraded the credit rating of the United States from Aaa to Aa1 over concerns about the US government’s growing debt, driven by high fiscal spending and budget deficits.
The double whammy of persistent debt and deficits means the Fed’s ability to fight inflation might be impaired and interest rate cuts could be pushed beyond when the Fed has suggested cuts could happen.
Additionally, the projected low in short-term interest rates (post-implied Fed rate cuts) is now approximately 50 basis points higher as of June 10.
The near-zero, low-rate environment investors saw following the Great Financial Crisis is not likely to return any time soon. Rather, rates may settle into a range around current, more average levels. As of June 10, the implied federal funds rate is 3.21% for January 2027 and in line with the average 90-day Treasury bill (T-bill) yield since 1934 of 3.41%.¹
A backdrop of normalized interest rates is a supportive tailwind for options-based strategies.
Higher short-term rates enhance premiums collected when selling (writing) index call options while simultaneously lowering the cost of protective index put options.
Upward pressure on longer-term rates dampens the effectiveness of fixed income allocations as a form of portfolio diversification; however, higher rates are beneficial to option pricing.

Key takeaway:

Investors looking to enhance diversification and reduce risk may benefit from Gateway’s options-based funds, which are poised to benefit from away-from-zero or rising interest rates, as well as periods of heightened volatility.
Option-writing premiums can be an effective source of income and/or provide a lower risk return potential.

Gateway market perspective – May 2025

1.45 MB

¹ Source: Bloomberg, L.P.

This material is provided for informational purposes only and should not be construed as investment advice. The analysis and opinions expressed represent the views of the author as of June 2025, and may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted. Actual results may vary.

Past performance is no guarantee of future results.

All investing involves risk, including the risk of loss of principal. Investment risk exists with equity, fixed-income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.

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Options may be used for hedging purposes but also entail risks related to liquidity, market conditions and credit that may increase volatility. The value of the strategy's positions in options may fluctuate in response to changes in the value of the underlying asset. Selling call options may limit returns in a rising market.

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