Evening Brief – 08.02.23
Fitch Ratings downgraded the long-term credit rating of the US by one notch to “AA+” from “AAA”, citing an expected fiscal deterioration over the next three years.
“There has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025,” wrote Fitch.
“The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management.”
Fitch’s downgrade comes approximately three months after President Biden negotiated an agreement to raise the debt limit just days before the US was set to default on its national debt.
Fitch cautioned at the time that the country’s creditworthiness was under jeopardy due to the country’s mounting debt, which is now well over $32 trillion, and Congress’ failure to handle it in a productive and responsible manner.
The agency also stated that a combination of tightening credit conditions, declining business investment, and a slowdown in consumption might cause the economy to enter a “mild” recession in the fourth and first quarters of 2023 and 2024, respectively.
The agency expects the US general government deficit to rise to 6.3% of GDP in 2023 from 3.7% in 2022.
Treasury Secretary Janet Yellen called Fitch’s downgrade “arbitrary and based on outdated data” from 2018 to 2000. “Fitch’s decision does not change what Americans, investors and people all around the world already know: that Treasury securities remain the world’s pre-eminent safe and liquid asset, and that the American economy is fundamentally strong.”
While the rating’s downgrade may have a largely symbolic impact, it comes as the US faces rising interest rates.
Some analysts, however, were surprised by the timing of the downgrading.
“I am very puzzled by many aspects of this announcement, as well as by the timing,” said Mohamed El-Erian, chief economic advisor to Allianz, in a tweet. “I suspect I won’t be the only one. The vast majority of economists and market analysts looking at this are likely to be equally perplexed by the reasons cited and the timing.”
“Overall, this announcement is much more likely to be dismissed than having a lasting disruptive impact on the US.”
There was disagreement about the consequences of the downgrade: some said it adds to equity investors’ concerns about the risks of recession and whether the equity rally is sustainable; others pointed to the complete lack of reaction in Treasuries and claimed it is a nothing-burger.
It seems unlikely that bond investors will completely eliminate US Treasuries from their books. If so, then what dollar-denominated bonds will they own?
In comparison, the implications of the Fitch downgrade appear comparatively muted: the last time the US sovereign credit rating was lowered – by S&P in 2011 — the S&P500 fell nearly 7% and temporarily entered a bear market. In addition, interest rates fell sharply, and gold soared.