Who is Fitch?
Fitch Ratings is one of the “Big Three” international credit rating agencies, the other two being Moody’s and Standard & Poor’s. These agencies assign ratings to the debt of countries, companies, municipalities, etc. that indicate overall creditworthiness.
What does it mean for a country’s debt to get downgraded?
Like credit scores for individuals, a borrower that is very creditworthy will have a higher rating than one less creditworthy. AAA is the highest rating possible and ratings go all the way down to D, which is an entity that has defaulted. AAA, AA, A, and BBB are all considered “investment grade” ratings with relatively low likelihood of default, with AA being the second highest rating.
Why did Fitch downgrade the US?
Fitch cited the high level of debt in the US as compared to its production as measured by GDP as well as rising issues with governance. Specifically, the consistent close calls with defaulting on debt through not raising the debt ceiling until the last minute.
Has the US debt been downgraded before?
Yes. In 2011 during the recovery from the Great Financial Crisis, Standard & Poor’s downgraded US debt one notch from AAA to AA+. There was an initial sell-off in markets, but they quickly stabilized.
What does this mean for investments?
Since the debt ceiling stand-off is in the rearview mirror and will not come around again until 2025, the reasons for concern given by Fitch are not imminent issues for markets. Stocks are down slightly and bond yields up slightly, but markets have mostly shrugged off the downgrade as this is something we’ve been through before and the risks are far enough in the future to not be immediately troubling for stocks.
Should I be worried?
Since the US dollar is the reserve currency, the only way the US could default on its debt is if it chose to through not raising the debt ceiling and intentionally defaulting. Politicians know this would be bad for the country, their own investment portfolios, and their votes, but this doesn’t mean they won’t continue to use the debt ceiling to play a game of chicken and try to secure compromises from the other side. As long as the debt ceiling remains intact and spending continues to rise, we will continue playing this game which has an extremely low probability of default but enough of one to spook markets every time we do it.
In summary, we think the effect of this downgrade on markets will be minor as the economy is humming along much better than expected in the short term. In the long run, finding a better way to rein in spending and have a more sustainable level of debt as compared to the country’s GDP will be highly advisable.
