Telemus Blog

Downgrading U.S. Debt

Written by Matt Dmytryszyn | Aug 14, 2023 1:06:23 PM

Telemus Weekly Market Review August 7th - August 11th, 2023

On the evening of August 1st, the bond rating agency Fitch downgraded its credit rating on the U.S. Government from AAA to AA+. This decision followed a downgrade of the United States in 2011 from fellow rating agency Standard & Poors from AAA to AA+. This downgrade is meaningful in that two of three major rating agencies now list the United States as a AA+ credit. The third major rating agency, Moody’s, continues to hold the U.S. at a rating equivalent to AAA, the highest rating. Since rating agencies will at times have different perspectives, standard market convention is to use the most common rating. Thus, even though Standard & Poors has viewed the U.S. Government has a AA+ credit for 12 years, the broader market has not since both Fitch and Moody’s held it at AAA. Following the move on August 1st where two of three major rating agencies now evaluate the United States as AA+, the market now recognizes the U.S. Government as a AA+ rated credit.

In its decision to downgrade the United States, Fitch highlighted the expected fiscal deterioration over the next three years and a growing government debt burden as justification for its decision. The rationale given for the downgrade was not a surprise, but the timing was. We and most market observers would have expected the downgrade to have transpired closer to May’s debt ceiling debate. 

Overall, the downgrade has not had a significant impact. A worst-case outcome could have been lenders that provide funds backed by government instruments (such as Treasury bonds) asking for more collateral now that Treasuries are no longer rated AAA. However, the market has seemed to continue function as usual and lending terms remain consistent. Second, one might have thought that Treasury yields might spike on the news. Bond yields have risen, but only moderately with longer term Treasuries up as much as a quarter of a percent since prior to the downgrade by Fitch. Overall, the downgrade has not had a notable impact on the functioning of markets and Treasury bond investors have only experienced a modest headwind to prices given the slight uptick in yields. 

Elsewhere, markets that one might have expected to suffer collateral damage haven’t. The dollar, which could have seen pressure given the downgrade to U.S. credit has moved modestly higher since the downgrade. Alternatively, gold, which is sometime seen as a hedge against the strength of the dollar and U.S. Treasuries, has fallen by 1.5% since Fitch’s decision. 

In our assessment, Fitch’s decision failed to highlight any new perspective around federal government deficits or their impact to the long-term stability of U.S. government debt. Therefore, as we assess the decision, we take some relief in that the downgrade risk on U.S. debt is off the table, at least for now. In addition, we haven’t seen any unusual movements in markets and Treasury yields remain near levels we find to be reasonable given current economic conditions. Overall, we believe the downgrade of the U.S. government debt is not a significant outcome that investors should be overly concerned with at this time. 

 

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