US credit rating downgrade by Fitch, the easons and implications

US credit rating

US credit rating downgrade by Fitch recap

What happened?

Fitch announced on August 2, 2023 that it would downgrade the US government’s credit rating from the top “AAA” to “AA+”.

Fitch’s reason for downgrade

Fitch’s (private, not listed) rationale is as follows:

  • “Fiscal deterioration is expected” over the next three years, and the government’s debt burden is high and growing.
  • The U.S. government lacks a medium-term fiscal framework and has made “limited progress” in addressing rising costs for Social Security, Medicare and Medicaid.
  • Over the past 20 years, the cycle of debt limit deadlocks and delays to resolve the crisis has repeated itself, which has eroded confidence in the government’s financial management.

U.S. Treasuries Current Rating

In 2011, Standard & Poor’s (S&P Global, ticker: SPGI) had already downgraded the rating of the United States to AA+ earlier. Among the three major credit rating companies, only Moody’s (ticker: MCO) still maintains the AAA rating in the United States.

What about other credit rating agencies?

As early as May 2023, DBRS Morningstar had already put the AAA ratings of long-term foreign currency and local currency issuers in the United States on the negative watch list. In the same way, China Chengxin Credit Rating Group also downgraded the U.S. sovereign credit rating from AAAg to AA+g.

My articles related to rating agencies

Content in my book

Credit ratings are extremely important for businesses, especially for companies and countries. As I introduced in Section 2-2 my book “The Rules of Super Growth Stocks Investing“, the three major corporate credit rating agencies, Standard & Poor’s, Moody’s, and Fitch, are well-known in the corporate world and the capital market.

Related posts on my blog

In the field of individual consumers, there are also three major consumer credit rating companies in the United States. Their main business is to evaluate personal credit ratings. Their status is like Taiwan’s Financial United Credit Information Center, and China’s Baihang Credit Information or Sesame Credit under Ant Group.

I suggest you refer to the following two posts of mine:

It’s not the first time downgraded

S&P did the same in 2011

In 2011, the S&P 500 plummeted 5.7% in August and another 7.2% in September, but in October the index returned to the price before the S&P downgrade.

What’s the difference between the two?

But looking back to 2011, when Europe was in the midst of a sovereign debt crisis, the financial market was already filled with a chilling atmosphere, and investors were strongly averse to risks. However, even in that atmosphere, the downgrade by S&P did not have much immediate impact. Investors instead piled into U.S. asset markets amid market turmoil, and U.S. Treasury yields fell (and prices rose) by the end of the year. Part of the reason was that the U.S. economy was relatively strong at the time, in stark contrast to the precariousness of the European Union.

In 2023, this time, the U.S. financial market is in full swing, doubts about the U.S. slipping into recession are fading, and the focus at this moment is on the most violent wave of interest rate hikes by the Federal Reserve (Fed) in decades Whether circulation can put out the fire of inflation. From this perspective, what the Fed will do next will have a far greater impact on US interest rates than Fitch’s downgrade.

Why downgrade?Compelling reasons

Soaring budget deficit

The US deficit is expected to reach US$1.7 trillion in 2023, which is equivalent to 6.5% of GDP, and this ratio is 5.5% in 2022.

Treasury interest out of control

The current interest rate is higher than that in 2011, the future economic growth rate is lower than that in 2011, and the difference between the real interest rate and the economic growth rate is about zero. That makes interest payments a growing source of the deficit, with interest payments climbing to 3.7% of GDP in the U.S. by 2033, up from 1.9% last year.

Even stronger evidence: By 2025, the U.S. will spend 10 percent of federal revenue on interest payments, compared with an average of just 1 percent for AAA-rated countries and 4.8 percent for AA-rated countries.

Bad for america in the long run

So why hasn’t the U.S. credit rating been lowered further? The reason is that the U.S. dollar’s reserve currency status and the size and safety of the U.S. national debt have given the U.S. unprecedented borrowing power.

But now countries around the world feel that the United States has repeatedly used the US dollar as a weapon in recent years, and has arbitrarily confiscated the huge US dollar assets of other countries; Although the progress is very slow, it is true that in the past few years, except for the important allies of the United States such as Western Europe and Northern Europe; countries around the world, regardless of size, have been de-dollarizing.

Coupled with the rise of China, a heavyweight country with an economic scale and national strength comparable to that of the United States has finally emerged in the world in the past century, which has enabled de-dollarization to be implemented. Investors can refer to the analysis of my previous post: “Will Sino-US confrontation, de-globalization, and de-dollarization affect the long-term investment value of US stocks?

What are the effects after the downgrade?

The stock market plummeted across the board

The second day after the U.S. was downgraded by Fitch, the Nasdaq fell 2%, the S&P 500 fell 1.38%, the Dow fell 0.98%, and Fei Banzhong fell 3.80%. VIX climbed to a new high in 5 months, 10 years U.S. Treasury yields rose above 4.10%.

U.S. Treasury yields soar

It is the same as the impact on the company’s corporate debt after the company’s credit rating is downgraded. After the credit rating of the United States was downgraded, the interest rate of the U.S. government’s treasury bonds will of course rise. As a result, the yield of U.S. Treasury bonds soared, and the 10-year U.S. bond yield immediately rose above 4.10%, which would increase the cost of borrowing funds in the market, which is not conducive to the operation of enterprises, and will also increase the cost of personal borrowing.

Mortgage interest rates gap up

Among them, the scope and amount of influence are the largest, and the most obvious and important indicator is that the interest rate of the mortgage immediately jumps up. U.S. mortgage rates have risen above 7%, hitting a nine-month high and approaching a 22-year high. According to data from the Mortgage Bankers Association, in the week ended August 4, the average 30-year fixed mortgage rate in the United States surged 16 basis points to 7.09%, the highest since November last year, while writing the second highest level since 2001.

 US credit rating

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