Concept of Credit Rating, Finance, Investment, And Banking

Fitch Ratings knocked down the U.S.’s credit rating from AAA to AA+ last week, citing the country’s ever-growing debt load and an “erosion of governance,” especially in fiscal management.

The country barely skirted a government shutdown in June when Republicans levied a series of demands that the Biden administration not spend money the previous Congress had voted for infrastructure and other projects. The shutdown was averted when the GOP and White House negotiated a compromise, including suspending the debt limit until January 2025.

However, the same drama is likely to play out again this fall when a new federal budget is due to be formulated.

The Biden administration fielded representatives to media outlets to denounce Fitch’s decision. The pundits called the downgrade “absurd” and “off-base.” The White House said the decision “defies reality.”

However, Fitch cited “a steady deterioration in standards of governance over the past 20 years.” Also, Fitch projects the federal debt to leap from 3.7 percent of GDP in 2022 to 6.3 percent this year.

The U.S. treasury announced last week that it will borrow more money as this year progresses to cover the rising debt. The lower credit rating is not expected to raise the government’s borrowing costs, analysts told the Financial Times.

U.S. treasury bonds remain the world’s largest bond market. Central banks and others buy them because they are seen as among the safest investments available. That “is unlikely to change because of Fitch’s decision,” the FT said.

“I think [the downgrade] is completely and totally irrelevant,” researcher Eric Winograd, an asset manager at AllianceBernstein, told the FT. “I’ve been trying to come up with a reason why investors would care about this and I can’t come up with one.

“The probability of the U.S. defaulting is exactly the same today as it was” before the downgrade, he added.

“We do not believe there are any meaningful holders of treasury securities who will be forced to sell due to a downgrade,” Goldman Sachs analysts wrote in a note. 

S&P’s ratings service downgraded the U.S.’s credit rating in 2011 when a similar budget drama took place and markets shrugged it off.

“No one buys treasuries because of the rating,” Peter Tchir,  chief of macro strategies at Academy Securities, said to the FT. “The downgrade by Fitch is a non-event for yields.”

After Fitch announced its decision, the yield on the 10-year treasury note ticked up 0.07 to 4.07 percent. The Standard & Poor’s 500 index dropped 1 percent.

TRENDPOST: The downgrade is a warning sign that prolonged political paralysis in Congress has consequences. When a new federal budget is being debated this fall, the most extreme Republican faction in the House of Representatives has pledged to oppose any budget that does not slash spending according to its wishes. 

While that would not lead to a default, it could easily confirm Fitch’s comment that the U.S. is unable to govern itself. That could easily spook ratings agencies to downgrade the U.S. again, which, in turn, would rattle investors and could force treasury bonds to pay more interest to assure buyers.

Result: the annual deficit and federal debt would increase, worsening Congressional dysfunction and increasing the likelihood of more skepticism by credit-raters and investors.

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