LONDON/WASHINGTON/DUBAI (UPDATE)– US Treasury Secretary Janet Yellen has labeled the recent credit downgrade of the United States by Fitch Ratings as “entirely unwarranted.” The downgrade, which saw the world’s largest economy’s rating drop from AAA to AA+, has sparked strong disapproval from both the White House and Treasury.
Meanwhile, markets reacted negatively to the downgrade, with stocks falling across Asia, Europe, and the United States. However, Treasury assistant secretary for financial markets, Josh Frost, downplayed the impact, noting “a very limited price response in markets.”
Fitch’s decision was based on the growing federal debt burden in the US and what the agency referred to as an “erosion of governance,” leading to repeated standoffs over the debt ceiling. However, Yellen, speaking at an event in Virginia, described the decision as “puzzling,” highlighting the country’s economic strength, robust job market, and cooling inflation.
Yellen emphasized that fiscal responsibility remains a priority for her and President Joe Biden, adding that the downgrade “does not change what all of us already know.” She further stated that “Treasury securities remain the world’s preeminent safe and liquid asset.”
Richard Francis, a senior director at Fitch Ratings, countered that the US needs to address the recurring debt limit impasses and find long-term solutions to its growing fiscal challenges if it wants a credit upgrade. He cited “constant brinksmanship surrounding the debt ceiling” and the inability of Republicans and Democrats to find “meaningful, long-term solutions” on issues like social security and Medicare.
Jared Bernstein, chair of the Council of Economic Advisers, also criticized the timing of the downgrade, calling it nonsensical and citing improvements under Biden’s administration.
The downgrade by Fitch marks only the second time a major ratings agency has lowered the US’s credit rating, and it has clearly struck a nerve in Washington. The back-and-forth between the Treasury and Fitch underscores the tension surrounding the country’s fiscal policy and governance, and the debate is likely to continue as the US grapples with its ongoing economic challenges.
Fitch’s decision to downgrade the US credit rating has sent ripples through the financial markets, reflecting broader concerns about governance and fiscal responsibility, said UBS Financial Services. While the immediate impact has been limited, the downgrade underscores the complex challenges facing the US economy and the need for careful policy navigation in the months and years ahead, it added.
Fitch Ratings, an international credit rating agency, announced a downgrade of the Long-Term Foreign-Currency Issuer Default Rating (IDR) of the US from the prestigious ‘AAA’ to ‘AA+’. This unprecedented decision has sent shockwaves through global economy, with implications for the nation’s financial stability and global standing.
The primary catalyst behind this historic downgrade is the steady erosion of governance standards over the last two decades, creating a palpable sense of concern among financial analysts and policymakers alike. Fitch highlights a trend of diminishing governance standards, particularly in managing fiscal affairs and addressing mounting debt issues. The perennial deadlock and last-minute resolutions surrounding the debt ceiling have gradually eroded investor confidence, casting doubt on the government’s ability to navigate its economic course with finesse.
This downgrade comes on the heels of a significant bipartisan agreement reached in June to suspend the debt limit until January 2025. Despite this effort, the persistent political standoffs and short-term fixes have cast a shadow over the nation’s fiscal management, fueling apprehensions about its economic trajectory.
Of paramount concern is the absence of a comprehensive medium-term fiscal framework, a crucial tool that many of its global peers possess. The absence of such a framework, coupled with a labyrinthine budgeting process, has hindered the implementation of effective fiscal policies. This has led to a disturbing cycle of mounting debt and recurring deficits, a situation that Fitch views with increasing alarm.
Forecasts paint a worrisome picture of rising general government deficits. Projections indicate that the deficit is poised to surge to 6.3 percent of the Gross Domestic Product (GDP) this year, a substantial leap from the 3.7 percent recorded in the preceding year. This uptick is attributed to a combination of weaker federal revenues, increased government spending, and a ballooning interest burden. The sudden shift of state and local governments from a surplus of 0.2 percent of GDP in 2022 to a projected deficit of 0.6 percent in 2023 has further exacerbated concerns about the fiscal landscape.
Efforts to address these challenges, such as the Fiscal Responsibility Act, offer a modicum of relief to the fiscal outlook. However, the impact of such measures remains modest, offering only a partial remedy to the mounting economic concerns. The Act is projected to generate cumulative savings of $1.5 trillion by 2033, equivalent to 3.9 percent of GDP. Yet, this comes against the backdrop of an anticipated $70 billion impact (0.3 percent of GDP) in 2024 and $112 billion (0.4 percent of GDP) in 2025, making the Act’s effectiveness in steering the economy into safer waters a subject of ongoing debate.
Equally concerning is the projection of a mild recession on the horizon, with the U.S. economy expected to contract in the next quarters. Factors contributing to this downturn include tighter credit conditions and declining business investments, creating a complex economic landscape that demands a delicate touch from policymakers.
The Federal Reserve’s efforts to counteract inflation through successive interest rate hikes also loom large in the economic landscape. Fitch’s projections indicate a potential further increase, complicating the Federal Reserve’s goal of achieving its inflation target. This, combined with the Federal Reserve’s reduction of holdings in mortgage-backed securities and U.S. Treasuries, tightens financial conditions further, adding an additional layer of complexity to the economic challenge.
Amidst these dire economic projections, the United States retains several strengths that bolster its credit rating. Its advanced, diversified, and high-income economy continues to command global respect, while the US dollar remains the world’s primary reserve currency, providing a unique avenue for financing flexibility.
However, Fitch’s evaluation of Environmental, Social, and Governance (ESG) factors casts a nuanced light on the nation’s governance standards. While strengths such as robust institutional capacity and a steadfast rule of law bolster the US’s standing, challenges related to political stability and corruption underscore the need for comprehensive reform.
The ripple effects of this downgrade are already being felt across financial markets, with potential implications for borrowing costs and investor sentiment.
Little lasting impact?
There is a “clear short-run implication” of the downgrade involving higher bond yields and a potential sell-off in the stock market and the dollar, said Mickey Levy of Berenberg Capital Markets told AFP.
But he does not expect long-run ramifications even if it could lead some investors to reduce their Treasury exposure in the near term.
Levy noted widespread awareness of the rising debt situation.
John Canavan, lead US analyst at Oxford Economics, does not expect the Fitch move to have a “lasting market impact.”
“One key reason for that is that the S&P downgrade more than a decade ago already broke the dam on this front,” he told AFP, noting that there was little lasting effect from that decision.
But “psychological support for dollar-denominated debt” could take a hit in the short-term, interfering with Treasury auctions at a time when it needs to ramp up the size of issuance, he said.
‘Steady deterioration’
In May, Fitch had placed the country’s credit on “rating watch negative,” reflecting increased political partisanship that hampered a resolution to raise or suspend the debt limit ahead of a looming deadline.
While lawmakers reached a bipartisan agreement to avert a catastrophic default, Fitch in June kept the US on negative watch.
“In Fitch’s view, there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters,” the agency said Tuesday.
“The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management,” Fitch added.
It also said the US government “lacks a medium-term fiscal framework” and has seen only “limited progress” tackling challenges related to rising social security and Medicare costs as the population ages.
This year, hard-right Republicans dominating their party’s narrow majority in the House of Representatives decided to use the debt limit vote as leverage for forcing President Joe Biden into accepting cuts to many Democratic spending priorities.
This triggered a test of political strength that threatened to end in chaos before the two sides reached an agreement.
US stocks fall
Wall Street stocks dropped Wednesday, joining a sea of red on global equity bourses after Fitch stripped the United States of its highest credit rating.
The Dow Jones Industrial Average shed almost 350 points, or 1.0 percent, to finish at 35,282.52.
The broad-based S&P 500 dropped 1.4 percent to 4,513.39, while the tech-rich Nasdaq Composite Index tumbled 2.2 percent to 13,973.45.
Fitch Ratings downgraded the United States from AAA to AA+ on Tuesday, citing a growing federal debt burden and an “erosion of governance” that has manifested in debt limit standoffs.
It is the second time a major ratings agency lowered the country’s rating, after S&P made a similar move in 2011.
LPL’s Quincy Krosby called the downgrade a “rationale for the market to sell off,” adding that “the market was due for a pullback” after continuing its 2023 rally in July.
Elsewhere, payroll firm ADP said the US private sector added 324,000 jobs last month.
This was down from a revised 455,000 figure in June but well above analysts’ consensus estimate of 185,000.
The report comes two days ahead of US government jobs data, which is closely watched for its potential bearing on central bank rate decisions moving forward.
Among individual companies, CVS Health shares jumped 3.3 percent following a mixed earnings report in which it topped analyst estimates but lowered its full-year forecast.
Advanced Micro Devices sank 7.0 percent after reporting a 94 percent drop in quarterly profits to $27 million. Analysts described the chip company’s report and forecast as lackluster.
Global stock markets slump
Global stock markets slumped Wednesday after Fitch stripped the United States of its top credit rating, citing a growing federal debt burden and an “erosion of governance.”
Fitch’s decision Tuesday night to downgrade the United States from AAA to AA+ sparked a fiery rebuttal from the Biden administration.
Treasury Secretary Janet Yellen characterized Fitch’s move as “entirely unwarranted,” calling it “puzzling in light of the economic strength we see in the United States.”
Wall Street’s main indices moved lower, with the S&P 500 finishing down 1.4 percent.
Europe’s main markets closed with losses of more than one percent.
“Market participants were already contending with the nagging notion that the stock market was overbought on a short-term basis and due for a pullback,” said market analyst Patrick O’Hare at Briefing.com.
“It didn’t necessarily need another excuse to continue with a consolidation trade, yet Fitch Ratings provided one after Tuesday’s close when it downgraded its US credit rating to AA+ from AAA.”
Ratings downgrades often mean it becomes more expensive for a government to borrow, but the status of US government bonds, or Treasuries, as a highly liquid safe-haven asset actually saw their yield dip immediately after the announcement.
The yield on 10-year bonds later rose in trading on Wednesday, which traders said was more due to expectations of higher volumes of US borrowing than the Fitch downgrade.
Downgrade ‘changes little’
Stephen Innes, managing partner at SPI Asset Management, said the downgrade will be “unlikely” to “cause a significant Treasuries sell-off or prompt a major shift in investor behavior mainly because investors experienced a similar downgrade from S&P in 2011 and came away unscathed.”
Michael Hewson, chief market analyst at CMC Markets UK, agreed the impact would be minimal.
“The loss of the AAA rating is damaging from a political point of view, but it changes little in the wider scheme of things when it comes to the investability of the US relative to its peers,” he said.
“It’s not as if China, or any other country in Europe is any safer when it comes to investability, as well as political stability.”
The downgrade follows a long, drawn-out row between Republicans and Democrats earlier this year over raising the US borrowing ceiling, which had fueled fears of a devastating default by the world’s top economy.
While a deal was eventually struck, the saga rattled markets and reinforced the sense of long-running deadlock on Capitol Hill that has seen the gears of government jammed up.
In an interview with CNBC, Fitch Ratings senior director Richard Francis pointed to a “pretty steady deterioration in governance over the last couple of decades” in the United States.
Among the elements he highlighted was January 6, referring to the date in 2021 when supporters of Donald Trump stormed Congress in a bid to prevent certification of his rival Joe Biden’s election victory.
Other factors, he added, included “constant brinksmanship surrounding the debt ceiling” along with Republicans and Democrats’ inability to generate “meaningful, long-term solutions” on fiscal issues surrounding programs like social security and Medicare.