On August 2, Fitch Ratings downgraded the US sovereign credit grade from AAA to AA+ due to concerns surrounding ballooning fiscal deficits and erosion of governance. The downgrade comes as a result of repeated debt limit emergencies over the past two decades. This action by Fitch follows a similar move made by Standard & Poor’s Global Ratings in 2011, which raised the US Treasury borrowing costs significantly. A lower credit rating could potentially lead to increased borrowing costs for the US. In this blog post, we delve into the reasons behind Fitch’s decision and the potential implications for the US economy.
Fitch’s Rationale: Fitch’s decision to downgrade the US credit rating was not entirely unexpected, as all major agencies had previously warned the country of the risks to its AAA credit grade. In May, Fitch had already placed the US credit on ‘Rating Watch Negative,’ indicating the possibility of a downgrade. The agency cited several factors contributing to the downgrade, including tax cuts, new spending initiatives, economic shocks, and a failure to address medium-term challenges related to rising entitlement costs. The rating agency also expressed concerns about a steady deterioration in governance standards over the past two decades and highlighted the negative impact of repeated debt-limit political standoffs on fiscal management.
Forecasted Debt Burden and Vulnerability: Fitch’s report predicts that the US’s debt burden will grow to 118 percent of its Gross Domestic Product (GDP) by 2025, more than two and a half times higher than the ‘AAA’ median of 39.3 percent. This higher debt-to-GDP ratio makes the US increasingly vulnerable to future economic shocks. The agency emphasized that the growing debt burden, coupled with eroding governance relative to peers, contributed to the downgrade.
Reactions from US Officials: US Treasury Secretary Janet Yellen responded to the downgrade, calling it ‘arbitrary and outdated.’ Yellen affirmed that US Treasury securities remain a preeminent safe and liquid asset and reiterated the strength of the American economy. Other economy watchers, including Mohamed El-Erian and former Treasury Secretary Larry Summers, expressed surprise and criticism over the timing and rationale behind Fitch’s decision.
Market Impact: Following the downgrade announcement, yields on two-year Treasuries fell by three basis points to 4.87 percent, while those on 10-year US bonds slipped one basis point to 4.01 percent. The yield on 30-year US debt rose to its highest level in nearly nine months. The stock futures also saw a decline, with Dow Jones Industrial Average futures sliding by 0.2 percent, and S&P 500 and Nasdaq-100 futures dipping by 0.3 percent and 0.4 percent, respectively. Asian stocks also traded lower, with the MSCI’s broadest index of Asia-Pacific shares falling by 0.5 percent.
Fitch’s downgrade of the US sovereign credit rating has raised concerns over the country’s fiscal situation and governance standards. The forecasted debt burden and the potential impact on borrowing costs may pose challenges for the US economy in the long run. While US officials have criticized the decision, it remains to be seen how the situation will evolve and how the government will address the challenges posed by the downgrade. As markets respond to this development, investors and economists alike will closely monitor the implications for the US and global financial landscape.