An oddly timed U.S. rating downgrade

In a way, at least, Fitch’s timing is quite fortuitous

From both a short-term market and a political angle, the decision to downgrade the United States' long-term ratings to 'AA+' from 'AAA’ looks like a bit of non-event. In one sense, at least, the timing was quite fortuitous. Today of all days, it was reassuring to read about the country’s “exceptional strengths,” continuing to support the Fitch ratings: ”Several structural strengths underpin the United States' ratings. These include its large, advanced, well-diversified and high-income economy, supported by a dynamic business environment. Critically, the U.S. dollar is the world's preeminent reserve currency, which gives the government extraordinary financing flexibility.”^[1]

To be sure, little of this would have come as news for many owners of U.S. Treasuries from overseas. Fitch’s views about the more negative aspects of the long-term fiscal prospects were just about as newsworthy. Still, just in case anyone was starting to worry – Asian trading initially looked a little wobbly – it was good to be reminded, on a day full of other, potentially worrying news coming out of Washington.

Market and policy implications

Other than that, it is hard to see why Fitch Ratings acted now, rather than at any point before, during or immediately after the latest debt-ceiling fight. Or, indeed, at plenty of other points during the past 12 years since the downgrade by S&P in 2011. For what it’s worth, we would argue that at least in terms of the “erosion of governance” and the “repeated debt-limit political standoffs and last-minute resolutions [that] have eroded confidence in fiscal management,” as Fitch mentions, the worst may actually be behind us.

None of which changes the fact that policies currently in place put the U.S. on an unsustainable path. According to the Congressional Budget Office, debt held by the public is expected to rise from 97% of gross domestic product (GDP) in 2022 to 181% in 2053 under current law.^[2] Scarier still, the current budget balance came in at minus 8.5% of GDP in June.^[3] That partly reflects delayed tax receipts. However, even the recent usual run-rate of -5% would certainly have raised alarm bells in another country or era, not least given an aging population requiring higher spending on health, in particular. Once again, neither the Congressional roadblocks towards legislative changes on entitlement spending or taxation, nor the downsides of potential “alternatives,” such as letting inflation run higher for longer, should come as news to any market participant.    

Asset-class implications

Given all the above, we expect to see little direct impact on markets. The rules on high-quality debt holdings put in place since S&P’s downgrade in 2011 make any significant forced selling very unlikely.^[4] With regards to Money Market Funds specifically, the SEC has designated government securities as “eligible securities” without reference to ratings^[5]. It is also worth noting that the downgrade does not affect other AAA-rated securities issued by U.S. entities, i.e. it will not directly affect bonds issued by U.S. federal agencies, other than the Treasury, government-sponsored enterprises, or U.S. municipalities. We therefore expect any spill-over in terms of risk sentiment in foreign-currency and equities markets to prove similarly short-lived, too. In the long term, however, there might be minor shifts towards AAA-rated bonds issued by other countries.