After twelve years, the United States has once again experienced a credit rating downgrade from an international agency, raising questions about what this could mean for global financial markets.
On Tuesday, credit rating agency Fitch stripped the U.S. of its highest credit rating, lowering it from AAA to AA+, citing concerns over an expected deterioration in fiscal conditions over the next three years and a growing burden of government debt.
This decision comes only two months after the Biden administration and the Republican-controlled House of Representatives reached an agreement to raise the government debt ceiling from $31.4 trillion.
Fitch expressed in a statement that despite an agreement between both parties in June to suspend the debt ceiling until January 2025, there has been a continuous degradation in governance standards, including fiscal and debt issues, over the past two decades.
U.S. Treasury Secretary Yellen responded to the downgrade, calling it "arbitrary" and "outdated." She strongly disagreed with Fitch's decision in a statement.
Cool Market Reaction, Wall Street Warns of Debt Risk
This is the second time the U.S. has experienced a rating downgrade, the first being when Standard & Poor's lowered its rating in August 2011.
Currently, among the three major rating agencies, only Moody's still maintains a AAA rating for the U.S. Both Fitch and Standard & Poor's have downgraded the U.S. credit rating to AA+.
Given the significant ripple effect that the Standard & Poor's rating event had on global financial markets twelve years ago, there are concerns that both the U.S. and global financial markets could experience turbulence on Wednesday.
However, the market reaction appears to be relatively mild.
Following Fitch's downgrade of the U.S. rating, the dollar index dipped briefly but has now recovered, U.S. stock index futures took a hit, and U.S. bonds rose.
Laura Fitzsimmons, Executive Director of Macro Rates and Foreign Exchange Sales at J.P. Morgan in Sydney, stated that although the dollar has weakened, the response so far has been fairly calm, and they do not anticipate further changes.
The experience in 2011 indicated that in such a situation, investors tend to shift towards quality currencies, which is a common occurrence when a country like the U.S., with its key global position, has its sovereign rating downgraded. Now, the situation seems to be the opposite.
Michael Schulman, Chief Investment Officer of investment firm Running Point Capital Advisors, stated that he has a feeling that the bond market overall will remain unaffected, considering the U.S. is generally seen as strong, but he believes this is a small chink in our armor. The reputation and standing of the U.S. have been damaged, but frankly, we've just experienced an actual competition a few months ago.
He feels this action validates the market's tense atmosphere from a few months ago.
Eric Winograd, Chief Economist at Alliance Bernstein, a U.S. asset management giant, stated that no one seriously considers the prospect of the U.S. being unable to repay its debt. Demand for long-term and short-term government bonds will continue, and he does not believe this downgrade is a significant signal of future troubles.
While the market reaction remains lukewarm, several analysts have again raised alarms about the ticking time bomb of U.S. debt.
Steven Ricchiuto, Chief U.S. Economist at Mizuho Securities, stated that this is the first additional warning for the U.S. government that its spending is unsustainable compared to its tax revenue. We've reached a point where the net interest on public debt exceeds our ability to grow out of the predicament. This basically tells you that there's an issue with the spending of the U.S. government. This is an unsustainable budget situation, as economic growth cannot even overcome this issue. Therefore, they'll have to address this issue, or face the potential consequences of further downgrades.
Analysts Mostly Surprised
Given that the debt ceiling crisis ended two months ago, many analysts are scratching their heads about the timing of Fitch's downgrade of the U.S. rating.
Keith Lerner, co-Chief Investment Officer at Truist Advisory Services in Atlanta, expressed surprise at the decision, calling it unexpected and a bit out of left field. As for the market impact, it remains uncertain. The market is currently in a stage where it can be easily influenced by bad news...
Wendy Edelberg, director of the Hamilton Project at the Brookings Institution in Washington D.C., also questioned the motive for the downgrade, which seems to be tied to fiscal conditions that have been generally good. Unless they believe fiscal conditions indicate a default risk, which she doesn't believe they are stating, she doesn't understand their reasoning.
Michael O'Rourke, Chief Market Strategist at JonesTrading, commented that based on the bond market performance today, someone seemed to know something was coming, as the Treasury market inexplicably weakened. Was he surprised by their move? Absolutely.
And finally, Jack Ablin, Chief Investment Officer at Cresset Capital Management, admitted to being surprised but at the same time not surprised.
He pointed out that the issue with sovereign debt is not just the ability to pay but the will to pay, which can cause problems. Every negotiation we get into becomes a mess, frustrating, and causes unnecessary pain. This is a reflection of the muddled negotiations we go through every time we have debt ceiling or budget talks. We're preparing for another shutdown in the fall. We have to get past this.
