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Fitch Downgrades the United States’ Long-Term Ratings

to ‘AA+’ from ‘AAA’

Portfolio Manager Jay Menozzi discusses the U.S. credit downgrade and its impact on the market

August 3, 2023
  • Fitch downgraded the U.S. long-term ratings one level from AAA to AA+. We believe the downgrade was in response to alarming budget deficits and the building U.S. debt pile due to pandemic stimulus, tax cuts, and recent government spending programs. At the same time the cost of servicing the debt has increased, the cost of borrowing continues to increase as the Fed pushed interest rates to a 22-year high.
  • Fitch forecasts U.S. debt to reach 118% of gross domestic product (GDP) by 2025, about three times higher than the median of 39% among countries awarded the highest AAA rating. It projects that the ratio will rise even higher in the longer term.
  • By contrast, the debt-to-GDP ratio in 2011 when the U.S. was downgraded by S&P was only 74.1% and was expected to rise to 80% or more of GDP by 2013, which at the time was the highest level of debt as a percentage of GDP since World War II and high relative to other “AAA” countries.  The downgrade was a result of concerns about political gridlock in Washington that was preventing any meaningful progress on debt reduction.
  • Tuesday’s downgrade comes as Fed Chair Powell’s comments last week indicated that the Fed is no longer expecting an economic downturn despite the most aggressive interest rate hikes in decades. Similarly, economists at major banks such as Morgan Stanley and Bank of America have scrapped their recession forecast. Furthermore, evidence of enduring strength among consumers and businesses keeps coming in, with the US adding more jobs than expected again in July.
  • By contrast, in 2011 when S&P stripped the US of its AAA rating, the economy was still hauling itself out of the global financial crisis and unemployment was around 9%. It is now at 3.6%, near the lowest level in decades. The 2011 downgrade was caused by debt ceiling posturing. Tuesday’s Fitch downgrade was caused by both debt ceiling risks and large budget deficits.
  • In response to the 2011 downgrade, all major U.S. stock indices immediately experienced significant declines. However, the U.S. Treasury Bonds that were downgraded rose in price and the dollar appreciated against other major currencies, indicating a general flight to quality. Any impact of the S&P downgrade slowly faded over the ensuing months.
  • Market reaction to Tuesday’s Fitch downgrade seemed even more muted. While equities did sell-off, that is likely related to recent earnings and higher long-term interest rates, as the yield curve steepened. Beyond rising long rates, the bond market mostly shrugged off the news with IG spreads trading sideways and HY selling off slightly with CDX rising 11bp. We expect this to have a negligible impact on US securities markets.

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