🔺 What to do when markets are at an all-time high? Find smart bargains, like these.See Undervalued Stocks

Fitch Downgrades U.S. Credit Rating

Published 08/02/2023, 04:09 PM
US10YT=X
-

In a surprise move on August 1, credit rating agency Fitch Ratings downgraded U.S. Treasuries to AA+ from AAA. Fitch’s explanation for the downgrade was that it “reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to AA and AAA rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.”

A Few Key Points:

  • This is not about the ability of the U.S. to service its debt. It’s about the willingness to service the debt. Fitch had warned during the debt ceiling standoff earlier this year that it was considering a downgrade because a country refusing to pay its debts in a timely way was not entitled to a AAA rating. It is the same reasoning used by Standard & Poor’s rating agency in 2011 when it downgraded U.S. debt to AA+ from AAA. Moody’s Investors Service still rates the U.S. as Aaa. We don’t expect the downgrade to affect many investments because few require AAA ratings.
  • The timing seems odd because it is well after the debt ceiling standoff was resolved and the U.S. economy is growing at a healthy pace. However, Fitch is looking at the upcoming budget battle in Washington this fall and anticipating the potential for another government shutdown if Congress can’t come to some agreement. This could weigh on economic growth and reduce tax revenues.
  • Fitch is considered the third-ranked rating agency and therefore, has less influence on the market than S&P or Moody’s. That may mitigate some of the impact of the decision.
  • Rising deficits and the ratio of debt to gross domestic product (GDP) is a concern over the longer run. The combination of tax cuts, followed by sharp spending increases during and after the pandemic has pushed the deficit and debt/GDP higher during the past few years. With the Fed hiking interest rates, the cost of servicing the debt is rising. Fitch projects the U.S. debt/GDP ratio to rise to 118% by 2025, which is significantly higher than the average for AAA-rated countries.
  • However, the U.S. has the ability to service the debt, even at higher interest rates. The economy is growing at a solid pace and foreign capital inflows continue to be strong. There is currently no reason to worry that the U.S. will default on its debt.

The initial move in the Treasury futures market was small, but yields have moved higher due to a combination of factors. The Treasury has announced larger-than-expected auctions of notes and bonds to make up for lack of issuance during the debt ceiling standoff. In addition, the recent move by the Bank of Japan to begin the exit of yield-curve control raises concerns about the country’s appetite for U.S. Treasuries. As a net creditor nation, Japan is a major investor in U.S. Treasuries. With their bond yields rising, there may be less demand for U.S. Treasuries at a time when issuance is rising.

In 2011 when S&P downgraded U.S. debt, yields fell over the subsequent few months because the economy was softening, inflation was declining, and yields were falling in other global markets. The European debt crisis was in the news, lending support to U.S. Treasuries as a safe haven. This time around central banks are hiking rates in most developed markets, creating a more challenging backdrop.

What Investors Can Consider Now

There is no question that U.S. Treasuries are still safe investments. The Fitch decision is highlighting long-term political issues that are preventing the government from coming to an agreement to slow the growth in debt/GDP. Nonetheless, there is still no substitute for U.S. Treasuries in the global economy. The U.S. market is still the largest, most liquid and safest in the world. Investors should not overreact to this announcement. There is no reason to alter a financial plan based on this decision.

***

Disclosure: TD Ameritrade® commentary for educational purposes only. Member SIPC. Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.

Latest comments

Loading next article…
Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.