The Implications of Fitch’s Downgrade of the US Credit Rating

Introduction

On Tuesday, Fitch downgraded the US credit rating to AA+ from AAA, in what many observers called a surprise, despite the company warning last May that it would downgrade the credit rating of the world’s largest economy. The market reacted quickly to this decision as global stock markets declined from Wall Street to Europe and even Asian equities, while 10- and 30-year Treasury yields rose and the dollar climbed to its 4-week high. But what does the US credit downgrade mean?

Not a Big Drop

Fitch has downgraded the US credit rating from AAA to AA+. At the time, Fitch joined rival Standard & Poor’s, which had previously done the same in 2011, when lawmakers did intensify the brinkmanship of a perpetual political struggle over whether to raise the country’s statutory debt limit. As a federal budget expert told CNN at the time, “We are the only developed country in the world that is openly defaulting.” However, going down from AAA to AA+ is like going from excellent to very good creditworthiness, said Mark Goldwyn, senior vice president and senior political director of the Committee for a Responsible Federal Budget.

Why did Fitch decide to downgrade the US rating?

In explaining the reason for the US downgrade, Fitch noted “an expected deterioration in financial health over the next three years, a high and growing general government debt burden, and deterioration in governance compared to peers rated ‘AA’ and ‘AAA’ over the past 20 years” over the last two decades to reduce debt and secure political gains until the last minute. Economists and analysts have dismissed a major Fitch downgrade, especially since it comes two months after lawmakers struck a deal to raise the debt limit and cut the deficit by $1.5 trillion over the next decade.

Bad Debt and a Good Economy

While the US debt situation may be unsustainable and negative for the future outlook for the US, the US economy, especially when compared to other advanced economies, is doing well. Inflation hit its lowest level since spring 2021, and economic growth, measured by GDP, was 2.4% year-on-year in the second quarter. Meanwhile, the eurozone has only recently emerged from a recession that began in the fourth quarter of 2022. Compared to other G7 countries, the US economy has maintained the strongest GDP growth to date.

US Debt

While equities sold off on Wednesday and 10- and 30-year Treasury yields hit their highest level since November, there were other factors besides Fitch’s downgrade. And given the United States debt situation, it is not viable as it increasingly crowds out the country’s ability to pay what Americans need and want in the coming years. And even the interest on the debt. Because the US spends more each year than it receives in taxes and fees, it borrows to make up the difference so that it can pay all its bills, which it does without fail. That is why it is considered a major credit risk.

In fiscal year 2022, the US paid $475 billion in interest, or 1.9% of GDP. According to a CRFB analysis of projections by the Congressional Budget Office, by 2033 this amount will almost triple to $1.4 trillion, or more than 3% of GDP. What’s more, CRFB notes that, given the country’s current fiscal trajectory, “by 2051, interest spending will become the largest component of the federal budget, surpassing Social Security, Medicare, and all other mandatory and discretionary spending programs.”