Bond credit ratings are a powerful tool that help investors assess how safe, or risky, a bond investment might be. Whether you’re considering U.S. Treasuries, municipal debt, or corporate bonds, these ratings offer a window into an issuer’s financial strength and the likelihood they’ll repay what they owe.
(New to bonds? Start with our introductory article here or explore our breakdown of bond types.)
Understanding Credit Ratings
Credit ratings are issued by three independent agencies – S&P Global, Moody’s, and Fitch – which analyze a bond issuer’s ability to repay its debts. While each agency uses a slightly different scale, their goal is the same: to estimate how likely it is that a bond issuer will make timely payments of interest and principal. Bonds are broadly categorized as:
High Yield (Junk) – Higher risk of default, but typically offer higher yields; rated BB+ and below.
Investment Grade – Considered safer and more stable; rated AAA to BBB- (S&P/Fitch) or Aaa to Baa3 (Moody’s).
Chart 1 (Source: https://www.etftrends.com/financial-literacy-channel/understanding-high-yield-bonds/)
Chart 1 captures a comparison of credit rating scales from S&P, Moody’s, and Fitch, showing how each agency classifies investment-grade and junk bonds. These ratings apply across all types of bonds, from Treasuries to municipals to corporate debt, and allow investors to compare credit risk consistently.
What Is Default Risk?
Default risk is the possibility that a bond issuer will fail to make timely interest or principal payments. Bonds with the highest credit ratings, like U.S. Treasuries (AAA), are considered extremely unlikely to default. On the other hand, bonds rated in the “junk” category may offer much higher yields but also carry real repayment risk.
This tradeoff between risk and reward is core to bond investing. The higher the risk of default, the higher the yield typically offered to attract investors.
Chart 2: Moody’s, Moody’s Seasoned Aaa and Baa Corporate Bond Yield [DAAA] [DBAA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DAAA and https://fred.stlouisfed.org/series/DBAA, June 30, 2025
Chart 2 illustrates the yield difference between Moody’s Aaa and Baa-rated bonds over a five-year period. Riskier Baa-rated bonds consistently offer higher yields than the safer, Aaa-rated bonds. This shows the risk/reward tradeoff investors have when choosing between various bond investments.
What to Watch For: Outlooks, Fund Impact, and Ratings Limitations
In addition to a bond’s current rating, agencies also issue credit outlooks to suggest how a rating may change over the next 6 to 24 months. Outlooks can be: Positive (potential upgrade), Negative (possible downgrade), or Stable (no expected change).
While not always accurate, these outlooks often affect investor sentiment, and can move prices, well before an actual rating change happens.
Even if you don’t buy individual bonds, ratings can still impact you. Many bond ETFs and mutual funds are required to hold only investment-grade bonds. When a bond falls below that threshold, fund managers may have to sell it, even if the bond’s fundamentals haven’t changed. This can lead to price drops, fund turnover, and wider market ripple effects.
It is also worth noting that credit ratings aren’t perfect. During the 2008 financial crisis, many mortgage-backed securities rated AAA suffered large losses. This reminds us that ratings are a starting point, not a substitute for deeper research.
Example: Ford’s Downgrade to Junk
In 2020, Ford Motor Company was downgraded from investment grade (BBB-) to high yield (BB+). As a result, many institutional bond funds, restricted to investment-grade holdings, were forced to sell Ford’s bonds. That surge in selling pressure drove prices down and raised Ford’s borrowing costs going forward.
These types of bonds are often called “fallen angels,” bonds that were once investment-grade but have since been downgraded. Conversely, “rising stars” are high-yield bonds upgraded back into investment-grade territory. These transitions can create both risks and opportunities for investors.
Final Thoughts
Credit ratings offer a helpful snapshot of bond risk, and a useful tool to compare fixed income investments. Whether you’re seeking conservative income through AAA-rated bonds or looking for higher returns with high-yield bonds, understanding what these scores mean can lead to more confident investing.
If you’re unsure how credit quality fits into your broader strategy, speak with your Grimes advisor to evaluate options aligned with your income needs and risk tolerance.
This article is part of an ongoing series aimed to help build overall financial literacy, and was co-authored by Grimes & Company’s 2025 Intern Gavin Walsh. While not a comprehensive deep dive into every single topic, it is designed to provide a helpful overview to key topics within the world of investing and financial planning. Please reach out to connect with an advisor or expert on the subject to learn more and start planning for your financial future.
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