Fitch announced last week that it downgraded the United States’ long-term credit rating from the AAA (the highest possible rating) down to AA+ (the second highest rating). For those that are unfamiliar, Fitch is the least well-known of the three major credit rating agencies, along with Moody’s (NYSE: MCO) and Standard & Poor’s (NYSE: SPGI). Fitch cited both financial and governance reasons for the downgrade, stating: “The rating downgrade of the United States 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.” In particular, Fitch described a “steady deterioration in standards of governance”. This included the recent tightwire negotiations in June regarding the infamous debt ceiling (which we previously discussed in our weekly newsletter) that once again risked the first ever default for the United States. Fitch had warned that this may result in a cut to the nation’s credit rating back in May, when clashes began between Democrats and Republicans over raising the borrowing limit. While the immediate crisis was averted (the debt ceiling has now been extended until January 2025), Fitch believes that in which the deal was negotiated has eroded confidence in the government’s fiscal management. Fitch also stated an increasing level of extremism in U.S. politics as another factor in issuing the downgrade. Most significantly, Fitch highlighted in a meeting with Biden administration officials the January 6th insurrection in Washington, D.C. as a significant threat to the stability of U.S. governance. Coincidently, Fitch’s decision to downgrade its credit rating of US debt came on the same day former US President Donald Trump was indicted for his conduct when trying to overturn his 2020 election loss. Finally, Fitch attributed part of the downgrade to the size of the country’s ever-expanding debt burden, which is expected to reach 188 percent of gross domestic product (GDP) by 2025. This level of debt is more than two and a half times higher than the AAA median of 39.3 percent, and is only likely to increase given expanding health costs and a growing interest burden as borrowing costs have risen. Fitch Follows S&P’s LeadThis is actually not the first time that the credit rating of the United States has been downgraded. Back in 2011 (after having just won the midterms) the Republican Party refused to raise the debt ceiling without major future spending concessions from President Obama’s administration. In an almost replica of the most recent saga that unfolded in June this year, talks repeatedly broke down and were finally resolved at the last minute. This led to considerable market volatility and uncertainty, which caused leading credit rating Standard & Poor's to cut its rating on US debt from AAA to AA+--a rating that has remained unchanged since this time. Until then, the US debt held a perfect credit ratings record since Moody’s Investors Service first assigned the United States a Aaa rating in 1917 (Moody’s has retained its rating of Aaa, the equivalent of S&P’s and Fitch’s AAA, to this day). Does it Matter?The country’s new rating of AA+ from Fitch puts the U.S. in line with the likes of Austria and Finland but below seven nations, including: Australia, Denmark, Germany, Luxembourg, the Netherlands, Norway, Singapore, and Switzerland. There are also two AAA-rated companies, Microsoft (NASDAQ:MSFT) and Johnson and Johnson (NYSE:JNJ), following the downgrade of ExxonMobil (XOM) back in 2016 (the first time since 1949) as oil prices plummeted. This compares to 60 companies that bore the AAA rating back in the early 1990s. Unlike the debt ceiling standoff, the rating change by Fitch does not appear to have rattled markets. The Dow Jones Industrial Average, S&P 500 and Nasdaq-100 have each rallied since the announcement, and prominent financial figures have cast doubt on the relevance of the news. In a recent interview with CNBC, JP Morgan (NYSE: JPM) Chairman and CEO Jamie Dimon labelled the move “mostly irrelevant”, stating that the market, rather than the major credit rating agencies, are responsible for determining borrowing costs (implying that the cost of debt is set by supply and demand, and the perception of buyers). He also suggested it is “ridiculous” that other countries hold higher credit ratings than the United States when they depend on the stability created by the U.S. (arguably they also have less diverse and innovative economies). US Treasury Secretary Janet Yellen responded to the downgrade by calling it “arbitrary” and outdated, noting: “Fitch’s decision does not change what Americans, investors, and people all around the world already know: that Treasury securities remain the world’s preeminent safe and liquid asset, and that the American economy is fundamentally strong.” The move does not appear to have influenced the world’s most famous investor either. Just days after Fitch’s downgrade was announced, it was revealed that Berkshire Hathaway’s (NYSE: BRK.B) cash and investments in short-term Treasuries had surged to US$147 billion at the end of the second quarter, representing a near all-time high for the conglomerate. Chairman and CEO Warren Buffett told CNBC that Fitch’s decision would not alter his investment strategy and he was not concerned about the U.S. Dollar nor the Treasury market–which is particularly notable given Berkshire’s significant investment in Moody’s. “Berkshire bought $US10 billion in US Treasuries last Monday..he said we bought $US10 billion in Treasuries this Monday…and the only question for next Monday is whether we will buy $US10 billion in three-month or six-month bills,” he said. Next HurdleWhile the downgrade by Fitch took investors by surprise and generated a lot of headlines, it does not appear to have had a material impact on markets–which at the moment, remain far more concerned about jobs, inflation and interest rates data. When questioned, the Biden administration declined to speculate on whether other major credit rating agencies would follow Fitch’s lead, but noted that Fitch had been the only agency with the US on a negative watch (all 3 major rating agencies now maintain a “stable” outlook).
Undoubtedly, however, the issue may arise again at the next round of debt ceiling negotiations or if the country experiences an increasingly greater debt burden or further political instability. Additionally, should the United States wish to reclaim its top-tier rating once again, it would likely require a permanent suspension of the debt ceiling–something that prominent figures have been advocating for since the initial 2011 saga. Dimon expressed such a view in his CNBC interview, stating: “We should get rid of the debt ceiling…It’s used by both parties in ways that sow uncertainty for markets.” Comments are closed.
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