What are the implications of the US debt being downgraded from AAA?

02/08/2023

The rating agency Fitch on Tuesday lowered the debt rating of USA from perfect AAA to AA+, due to “governance erosion” after repeated crises over the country’s debt issuance limit.

The Fitch document reads that “the downgrade (of the note) of the United States reflects the fiscal deterioration expected in the next three years”, alluding to the “erosion of governance” after “repeated impasses on the limit of indebtedness and last minute resolutions”.

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It is worth remembering that on several occasions the Government of Joe Biden has had trouble passing the debt ceiling, in a context in which the country spends much more than it receives. Hence Fitch also targeted “a high and growing public debt burden” in the United States.

nonetheless, the biggest impact on the world’s biggest economy will be largely symbolic, because US debt was long considered one of the safest havens and the downgrade suggests it has lost steam.

Such a downgrade has potential repercussions on everything from the mortgage rates Americans pay for their homes to the contracts signed around the world.

What is the AAA rating?

The AFP Agency states that to assess the solvency of States, communities or companiesthe three main rating agencies in the world -S&P Global, Fitch and Moody’s- use scales of letters or grades, ranging from AAA, considered above any risk, to C or D, which indicate possible repayment defaults.

The measurements are made by analyzing parameters of economic growth, indebtedness, deficit, expenses, fiscal income, and the diagnosis serves as a guide for investors.

That also means that the lower the grade assigned, the higher the interest that investors will request to lend money to a State or to a company, because its debt will be considered more risky.

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The Triple A Country Club

Solo a handful of countries retain the highest score from the three big rating agencies: Australia, Denmark, Germany, the Netherlands, Sweden, Norway, Singapore, Switzerland and Luxembourg.

Others only have the best rating in one or two of the big three credit bureaus.

In Europe several countries lost the highest note after the financial crisis of 2008.

In 2011, S&P Global stripped the United States of its AAA rating after a lengthy fight in Congress over the debt limit, but Moody’s, which has records going back to 1949, continues to give it top marks.

The United States needs to solve the recurrence of the problems linked to its debt issuance limit, and find “long-term” solutions, if it wants to recover triple A, Richard Francis, head of Fitch Ratings for the Americas, declared this Wednesday on CNBC.

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The main implications

According to AFP, the loss of the triple A sends a signal to the markets, which for the moment is mostly symbolic, since the United States continues to have a positive grade and its bonds are still considered the safest and most liquid in the world. .

The rate of return on the 10-year Treasury bond, a benchmark for the market, broke the 4% barrier for the third time this year before Fitch’s announcement, but went back below that level immediately after.

The rates on those bonds are the yield they offer or the interest the Treasury pays for borrowing. The upward pressure in recent months is due above all to the increase in the reference rates of the Federal Reserve (Fed), the central bank of the United States.

The Fed has successively increased its interest rates in an attempt to make credit more expensive and thus cool consumption and investment, and thereby contain the pressure on prices in a context of high inflation.

Fitch explained in its conclusions that “the US dollar is the world’s most important reserve currency, giving the government extraordinary funding flexibility,” suggesting that The US will continue to easily find buyers for its debt.

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The US economy is strong and the unemployment rate is under 4%, but “the public deficit is on track to reach 6% of GDP in the current fiscal year”Capital Economics analysts noted.

According to that consultancy, the interest costs of government debt may double in the coming years, although much will depend on the Fed’s ability to quickly initiate a cycle of interest rate cuts.

If that doesn’t happen, “then the debt dynamics can quickly become unsustainable,” the report warns.

United States reacts

White House press secretary Karine Jean-Pierre said in a statement that “we strongly disagree with this decision” and cited similar concerns about Fitch’s model.

“Y It’s clear that the extremism of Republican officials—from seeking non-compliance to undermining governance and democracy to seeking to extend deficit-fighting tax handouts for the wealthy and corporations—is a continuing threat to our economy.”, he added.

The reduction in the gringo note is “unjustified”, launched on Wednesday the Secretary of the Treasury, Janet Yellen, adding that the agency’s assessment does not correspond to the current vigor of the world’s biggest economy.

“Fitch’s decision is surprising considering the strength of the economy we are seeing in the United States. I deeply disagree with Fitch’s decision, and I think it is totally unjustified,” the official said during a visit to a tax center in McLean, Virginia.

“The evaluation is based on outdated data and does not reflect the improvements in many indicators, including those of governance, that we have observed for two and a half years” since Biden occupies the White House, argued his Economy Minister.

And he reiterated that “Fitch’s decision does not change anything to what we all know: Treasuries are the world’s biggest safe and liquid asset, and the US economy is on solid fundamentals”.

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But it is worth remembering that at the end of May, in the midst of a battle between the government and the opposition in Congress to raise the debt ceiling and avoid a default, the agency warned that it could revise triple A downwards. After the agreement reached in extremis between the two parties, the agency declared that it was keeping the note under surveillance and deplored, in passing, the “political polarization” in the country.

This Wednesday, the head of Fitch for the Americas, Richard Francis, justified the decision again, when questioned by CNBC: “Among the important elements for us is the fact that governments, from both camps, Republicans and Democrats, were unable to find lasting solutions to fix growing fiscal problems”.

“We have seen a fairly steady deterioration in governance over the last few decades,” he emphasized. This is illustrated by “the always tightrope resolution of the debt ceiling issue”.

The United States needs to solve the recurrence of the problems linked to its debt issuance limit, and find “long-term” solutions, if it wants to recover triple A, concluded the person in charge of Fitch.