The surprise move takes the rating to AA+ from AAA.
In a surprise move on August 1st, credit rating agency Fitch Ratings downgraded U.S. Treasuries to AA+ from AAA.1 Fitch's explanation for the downgrade was that it "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 that has manifested in repeated debt-limit standoffs and last-minute resolutions."
A few key points:
- This is not about the ability of the U.S. to service its debt. It's about the willingness to service the debt. Fitch had warned during the debt-ceiling standoff earlier this year that it was considering a downgrade because a country refusing to pay its debts in a timely way was not entitled to a AAA rating. It is the same reasoning used by Standard & Poor's rating agency in 2011 when it downgraded U.S. debt to AA+ from AAA. Moody's Investors Service still rates the U.S. as Aaa. We don't expect the downgrade to affect many investments, because few require AAA ratings.
- The timing seems odd because it is well after the debt-ceiling standoff was resolved and the U.S. economy is growing at a healthy pace. However, Fitch is looking at the upcoming budget battle in Washington this fall and anticipating the potential for another government shutdown if Congress can't come to some agreement. This could weigh on economic growth and reduce tax revenues.
- Fitch is considered the third-ranked rating agency and therefore, has less influence on the market than S&P or Moody's. That may mitigate some of the impact of the decision.
- Rising deficits and the ratio of debt to gross domestic product (GDP) is a concern over the longer run. The combination of tax cuts, followed by sharp spending increases during and after the pandemic has pushed the deficit and debt/GDP higher during the past few years. With the Fed hiking interest rates, the cost of servicing the debt is rising. Fitch projects the U.S. debt/GDP ratio to rise to 118% by 2025, which is significantly higher than the average for AAA-rated countries.
- However, the U.S. has the ability to service the debt, even at higher interest rates. The economy is growing at a solid pace and foreign capital inflows continue to be strong. There is currently no reason to worry that the U.S. will default on its debt.