Fitch Ratings, one of the three major credit rating firms, has downgraded the United States’ sovereign credit grade from AAA to AA+. The decision is a result of the country’s growing fiscal deficits and what Fitch describes as an “erosion of governance” that has led to repeated debt limit clashes over the past two decades. This downgrade echoes a similar move made by S&P Global Ratings more than a decade ago.
Fitch cited tax cuts, new spending initiatives, and multiple economic shocks as contributing factors to the ballooning budget deficits. Additionally, the agency highlighted the unaddressed medium-term challenges related to rising entitlement costs. In a statement, Fitch said, “The rating downgrade of the US 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.”
US Treasury Secretary Janet Yellen swiftly responded to the downgrade, dismissing it as “arbitrary” and “outdated.” Yellen emphasized that Treasury securities remain the world’s premier safe and liquid asset and reiterated the fundamental strength of the American economy.
Fitch had previously indicated its consideration of a credit grade cut back in May, during a period of disagreement between Democrat and Republican lawmakers over raising the nation’s borrowing limit. At that time, the US Treasury was only weeks away from running out of cash. Although the crisis was ultimately averted, Fitch expressed concern over the repeated debt-limit clashes and last-minute resolutions, which have eroded confidence in the nation’s fiscal management.
The downgrade is also attributed to the rapidly increasing debt burden of the United States. Fitch predicts that by 2025, the country’s debt will reach 118% of its gross domestic product (GDP), more than two-and-a-half times higher than the median debt of AAA-rated countries, which stands at 39.3%. Furthermore, Fitch projects that the debt-to-GDP ratio will continue to rise, leaving the United States vulnerable to future economic shocks.
The news of the downgrade surprised several economic commentators. Mohamed El-Erian, the chief economic adviser at Allianz SE and a Bloomberg Opinion columnist, expressed his puzzlement on social media, particularly regarding the timing of the announcement. Former Treasury Secretary Larry Summers acknowledged the long-term fiscal challenges faced by the United States but criticized the credit rating agency’s decision as “bizarre and inept” given the current strength of the economy.
In response to the news, yields on US two-year treasuries fell slightly, while yields on 10-year US bonds increased marginally. The dollar also experienced a dip against the euro and yen.
It is worth noting that S&P’s downgrade of the US credit rating in 2011 triggered a global selloff in risk assets, but paradoxically boosted treasuries as investors sought out safe havens. The yield on 30-year US debt reached its highest point in almost nine months on Tuesday as the Treasury Department prepared to issue longer-dated securities to fund the widening budget deficit.
The downgrade by Fitch now leaves the United States with two AA+ ratings. This may pose a problem for funds or index trackers that have a mandate to only invest in AAA-rated assets, potentially leading to forced sales for compliance reasons. Moody’s Investors Service, however, still rates the US sovereign Aaa, its highest grade.
