Credit rating agency Fitch has revised its rating of the US’s creditworthiness downwards due to ‘erosion of governance’ and ‘political deadlock’ over the debt ceiling. Five questions about cause and effect.
America is no longer branded as an ultra-safe investment. Credit rating agency Fitch downgraded the rating from AAA to AA+. This is not entirely unexpected. Fitch had already announced in May that it was considering downgrading the credit score. At the time, politicians in the United States were still engaged in a battle over the debt ceiling, the maximum amount of government debt allowed. If it was not raised in time, one of the richest countries in the world was at risk of bankruptcy. In late May, Democrats and Republicans finally reached an agreement.
Why did Fitch downgrade?
Fitch argues that there is an “erosion of governance” due to “repeated political deadlocks over the debt ceiling and last-minute amendments”. Additionally, the rating agency expects the US budget deficit to rise to 6.3 percent of gross domestic product (GDP) this year from 3.7 percent last year. Public debt could rise from 113 percent of GDP this year to more than 118 percent in 2025.
Why does it matter what Fitch thinks?
Rating agencies make an independent assessment of the financial health of governments and companies seeking to borrow money and the prospects of repayment by investors lending that money. Companies should pay for that analysis, not governments. A low rating, low creditworthiness and high interest rate will cause investors to borrow money. Belgium has an AA rating by Fitch.
How did the US government respond?
US Treasury Secretary Janet Yellen called Fitch’s decision “arbitrary” and “outdated”. “It doesn’t change what Americans, investors and people around the world already know,” he said, “that our government bonds are the world’s safest and most liquid investment, and that the U.S. economy is fundamentally strong.”
Research firm Capital Economics also thinks this is a slightly different decision from Fitch. “The downgrade comes at a time when the U.S. economy appears to have succeeded in its near-impossible trick of bringing inflation back to target levels without triggering a recession,” the agency said in a note.
What are the consequences of this decrease in rating?
They are limited. AA+ still represents very low bankruptcy risk. So the reaction in financial markets was moderate, especially since Fitch was not the first to strip the US of its highest credit rating among the three major rating agencies. Standard and Poor’s (S&P) already did this in 2011, and because of the malaise over raising the debt ceiling. At Moody’s, the US still has a prestigious AAA rating.
A downgrade doesn’t mean investors will question the credit. When the S&P downgraded the US, investor demand for US government debt actually increased. During times of unrest, riskier investments usually sell off, while a flight to safe havens begins. That, and the US government debt is still the best. In 2011, the US also drew comparisons with the Eurozone, which was then in the midst of a debt crisis.
What if America loses its top credit score anywhere?
If Moody’s also decides to lose the US’s top rating, there will be more consequences for the US government bond market. Funds with a mandate to invest only in AAA-rated bonds must sell that government paper.
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