Second major US ratings agency to downgrade the US to ‘AA+’. The first rating agency got whacked by the US government.
By Wolf Richter for WOLF STREET.
Following the shocker of an announcement by the Treasury Department yesterday that it would have to borrow $1 trillion in the quarter through September and another $852 billion in the quarter through December, on top of the $32.6 trillion the government already owes, Fitch Ratings threw in the towel today and became the second major US rating agency to downgrade the US of A.
Fitch cut the long-term credit rating of the US to ‘AA+’ from ‘AAA’. It already had the US on negative outlook, meaning a downgrade was possible. With the downgrade today, Fitch removed the negative outlook and assigned a stable outlook.
As reason for the downgrade, Fitch cited a litany of issues, which it summarized:
- “The expected fiscal deterioration over the next three years
- “High and growing general government debt burden
- “Erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.”
Here are some key points that Fitch made:
“Erosion of Governance”: Fitch cited “a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025. The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management.”
“The government lacks a medium-term fiscal framework, unlike most peers, and has a complex budgeting process. These factors, along with several economic shocks as well as tax cuts and new spending initiatives, have contributed to successive debt increases over the last decade.”
This is what the last half of these “successive debt increases over the last decade” looks like:
Rising Government Deficits: Fitch said that it expects the general government (GG) deficit to reach 6.3% of GDP this year, from 3.7% in 2022, “reflecting cyclically weaker federal revenues, new spending initiatives and a higher interest burden.” Fitch forecasts the deficit to reach 6.6% of GDP in 2024 and 6.9% of GDP in 2025.
Rising Government Debt: Fitch said that the debt-to-GDP ratio at 112.9% in 2023 is “well above the pre-pandemic 2019 level of 100.1%.” It expects the ratio to reach 118.4% by 2025. “The debt ratio is over two-and-a-half times higher than the ‘AAA’ median of 39.3% of GDP and ‘AA’ median of 44.7% of GDP,” it said.
“Fitch’s longer-term projections forecast additional debt/GDP rises, increasing the vulnerability of the U.S. fiscal position to future economic shocks,” Fitch said.
Medium-term Fiscal Challenges Unaddressed: “Over the next decade, higher interest rates and the rising debt stock will increase the interest service burden, while an aging population and rising healthcare costs will raise spending on the elderly absent fiscal policy reforms,” Fitch said.
But the US of A still has some strengths, Fitch said: a “large, advanced, well-diversified and high-income economy, supported by a dynamic business environment.” And of course, inevitably, the US has the dollar, “the world’s preeminent reserve currency, which gives the government extraordinary financing flexibility.”
Fitch projects a US recession in Q4 this year and in Q1 next year, the same recession that has gotten moved out every quarter for over a year. Someday we’ll get it. Even the Fed has given up on its recession call for this year. Fitch is still clinging to it.
Fed Tightening: Fitch pointed at the rate hikes so far, and “expects one further hike” by September. “The resilience of the economy and the labor market are complicating the Fed’s goal of bringing inflation towards its 2% target,” it said. It sees no rate cuts until March 2024. And it cited QT, “which is further tightening financial conditions.” Though, however, but, uhm, the financial conditions have barely tightened outside the banking sector.
Second downgrade for the US of A.
Fitch has now become the second of the top three US rating agencies to knock the US off its triple-A ratings.
In 2011, S&P downgraded the US to AA+, from AAA, after another especially entertaining debt ceiling farce in Washington. But the downgrade did not go over very well. Politicians from both parties lambasted it. The Justice Department started to investigate S&P’s role in the rating of some MBS that blew up during the Financial Crisis and ultimately sued S&P and its parent McGraw Hill Financial, in 2013, accusing it of defrauding investors, and seeking $5 billion. In 2015, S&P settled the allegations for $1.375 billion. So that was an expensive downgrade.
Not that it mattered. Downgrades should make it more expensive for governments to borrow. But they don’t.
Japan, which is in even worse fiscal shape than the US — and which Fitch rates ‘A’, four notches below the US’s new ratings — has the lowest yields rates in the world, not because of any credit ratings, but because of central bank policy.
US Treasury yields continued to meander lower after the S&P downgrade in 2011. By August 2020, the 10-year yield had dropped to an all-time low of 0.5%.
But that era is over. Since August 2020, yields have jumped, thanks to Fed tightening — and not due to any downgrades. Today, the 10-year yield is back over 4%.
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