Fitch Downgrades US Treasurys: A Tale of Debt and Dysfunction

On 1 August, Fitch Ratings announced it was cutting the long-term rating of US Treasurys one notch from AAA to AA+ but switching its outlook from negative to stable.1 To many, the move recalled memories of when the S&P downgraded US Treasurys in August 2011. The market response to the downgrade in 2011 was dramatic, with a large stock market selloff and, paradoxically, a rally in long Treasurys. So far, markets seem to have had a fairly minor reaction to the Fitch downgrade. Perhaps markets had seen the writing on the wall. I think few would dispute the reasons Fitch cited for the downgrade. Here, I share my take on Fitch’s reasoning and highlight key differences between this event and the S&P downgrade of 2011.

Key Drivers of the Downgrade

  1. Fitch expects high and rising budget deficits (as a percentage of GDP) over the near-term.

My take: Congressional Budget Office (CBO) projected federal budget deficits seem grim. For all the fretting about deficits in the 1980s and the early 1990s, projected deficits have gotten chronically worse. I think the CBO’s projections may be too optimistic because it assumes that all tax cuts will expire as currently scheduled by law, but that may not happen.

CBOs Baseline

2. Fitch projects a steady rise in the ratio of public debt to GDP.

My take: CBO released a thirty-year projection ("extended baseline") of the debt-GDP ratio on 28 June. The federal public debt was 98% of GDP in fiscal year (FY) 2022. CBO expects the ratio to rise to 115% in FY 2032, which would be a record high in just a decade. CBO projects it will continue to rise to 181% in FY 2053. I expect it to keep rising, except if the rise were to trigger a financial crisis before the ratio got that high. Fitch noted that the current debt-GDP ratio in the US is more than 2.5x times higher than the median of both AAA and AA rated countries. In fact, the US currently has one of the highest debt-GDP ratios of any sovereign government regardless of credit rating.

cbo forecast