FitchRatings downgrades the US: does anyone care?
FitchRatings cut the rating of the US (sovereign debt) from AAA to AA+ on Tuesday afternoon, following putting the country on negative watch for a potential downgrade in May. The #FitchRatings press release is here, worth reading because it provides the rationale for the downgrade in a concise form. Interviews with FitchRatings analyst Richard Francis, co-head of Americas Sovereign Ratings and in charge of the decision, are on #YouTube, with Bloomberg here and CNBC here.
Fitch is not the first rating agency to downgrade the US from the coveted AAA status. Standard & Poor’s (S&P Global Ratings) downgraded the US to AA+ 12 years ago in August 2011 (#Reuters press release here), following the difficult recovery the country (and world) was facing from the GFC.
Naturally, the Biden Administration does not agree with the downgrade, especially the timing, in that US unemployment is at a record low and the US economy is continuing to exhibit strength and resiliency in spite of the expectation of a pending recession. The official response by the Administration from Secretary of the Treasury Janet Yellen is here, and below is an extract from that four paragraph statement:
“Over the past few years, the United States has undergone a historically fast economic recovery from a deep recession. Today, the unemployment rate is near historic lows, inflation has come down significantly since last summer, and last week’s GDP report shows that the U.S. economy continues to grow. The American economy remains the world’s largest and most dynamic economy, with the deepest and most liquid financial markets in the world. To build on this, President Biden and I have been focused on making critical investments in our country’s core economic strength and productive capacity.”
US Treasuries were slightly weaker following the announcement, but investors attributed this to stronger-than-expected jobs data (JOLTS report) released earlier this week and not to the Fitch downgrade. The 2- and 10-year US Treasury constant maturity bond yields rose to 4.88% and 4.08%, respectively, by Wednesday’s close, with the 2-year UST yield unchanged from Monday’s close prior to the downgrade and the 10-year yield 9bps higher. The US Dollar strengthened each day through Wednesday’s close in spite of the Fitch downgrade.
The FitchRatings’ announcement as a non-event as far as global financial markets because it has done nothing to undermine confidence in the status of the US Dollar as the global reserve currency, and it has clearly not affected US Treasury bond market, which remains by far the deepest and most liquid government bond market in the world by a landslide. This is the reality, like it or not – the US remains a unique beneficiary of the status of its robust and transparent financial markets and freely-exchangeable and floating currency; there are simply no alternatives at the moment. However, before the Fitch downgrade is completely dismissed as a non-event, there are three things I would like to say that I think are important to understand.
1. The rationale for the FitchRatings’ downgrade is not without merit even if the timing might seem suspect. The first two issues Fitch highlights are “erosion of governance” – referring specifically to the most recent debt ceiling showdown and more generally to an increasingly partisan political landscape – and “rising general government deficits”, with the government deficit expected to increase to 6.3% of GDP in 2023 from 3.7% in 2022. Fitch is also expecting a mild recession in 4Q23 / 1Q24. It is interesting to note that the downgrade of the US by S&P Global Ratings 12 years ago also followed a protracted debt ceiling discussion involving Congress and the Obama Administration, not dis-similar to the recent debt ceiling wrangling that took weeks to resolve. For those readers that want to blame one party or the other for the Fitch downgrade, rest-assured that both Democratic and Republican Administrations have been equally guilty at running up US government debt with impunity, as you can see in the graph below that shows deficits-to-GDP for the last 50 years.
The last time the US balanced the budget was under the second Clinton Administration in the late 1990s. Since then, a series of Democratic and Republican Administrations – with a few crises mixed in (e.g. 9/11, the GFC and COVID-19) – have resulted in the deficit as a percent of GDP getting larger and larger.
There is little doubt that the downgrade, as meaningless as it is to global investors, will result in the usual political finger-pointing in Washington DC. This “blame game” is unfortunate, and politicians should instead use the downgrade as a catalyst to make some bipartisan changes, including:
Eliminating the absolute government-approved debt ceiling that brings these contentious discussions to the front pages for several weeks every two or three years, rattling financial markets during weeks of un-necessary drama; and
Addressing the ballooning US deficit through a combination – if needed – of lower expenditures and higher revenues, as painful as it is for me to write this. This would be a form of fiscal restraint, and the unpleasant combination of lower government expenditures and higher taxes – leading to lower deficits – would inevitably lead to a prolonged period of slower US economic growth, a price that will eventually need to be paid for years of undisciplined, increasing budget deficits.
At some point in the years ahead, alternatives could develop for both the US Dollar as the most important global reserve currency and / or the US Treasury bond market as the ultimate risk-free asset. When and if this were to occur, the US would find itself quickly held to the discipline of every other country in the world, and the pain would be beyond imagination. Let’s not go there.
2. The table below contains the ratings of the top 15 largest economies in the world and the European Union, along with relevant statistics including deficit-to-GDP (2023 and 2024), gross debt-to-GDP (2023), and expected 2024 growth rate.
Looking at this table you will see that the US is one of the countries that is expected to have the highest deficit-to-GDP in 2024, only slightly better than emerging markets countries India and Brazil (of the top 15 largest economies), and substantially worse than those countries with at least two triple-A ratings in the table, including Germany, Australia, Canada and the European Union. Looking at this table, the cynical side of me cannot help but wonder why the downgrade took so long.
3. It does not appear that the downgrade of the US’s sovereign ratings by Fitch to AA+ will affect the ratings of the only two remaining US companies with triple-A ratings from all three rating agencies: Microsoft and Johnson & Johnson. I mention this because some companies, especially in emerging markets, have their foreign debt ratings “capped” by the rating of their country of domicile. Clearly, #MSFT and #JNJ are global companies whose businesses transcend that of their country of incorporation.
This is my take on the Fitch downgrade, perhaps not meaningful at the moment to investors based on the reaction of financial markets, but a clear warning sign to politicians on both sides of the aisle that bipartisan action is needed sooner rather than later to right the ship. As strange as the timing of FitchRatings’ decision to downgrade the US might appear, it is hard to argue the downgrade was not deserved because the US government has, in essence, “earned it.”