Fitch ratings downgraded United states long term foreign currency issuer default rating to AA+ from AAA, earlier in May it had kept US rating on negative watch citing ‘debt ceiling’ drama. Later, officials negotiated a deal to settle debt ceiling issue but that uncertainty kept markets on toes. After deal markets were seeing one way rally around the world but this downgrade came as a shock to markets as markets around the world closed in red today.
US benchmark Dow jones(DJIA) shed 0.90% to close at 35,309.36 falling 321 points, broader index S&P500 closed at 4,513.46 shedding 63 points or 1.38%, tech heavy NASDAQ fell sharply to 13,973.45 shedding 310.45 points or 2.17%. Markets in Europe fell 1-2% at close and major markets in Asia fell 1-4 % in process to digest this rating downgrade. In India, benchmark Nifty50, S&P Sensex both fell more then 1% after rallying continuously for days.
Basis for Fitch ratings downgrade
Richard Francis, Fitch’s co-head of the Americas sovereign ratings said there is a steady deterioration in US key metrics over the years as, in 2007, general government debt was less than 60% and now it’s 113%, so there has been a clear deterioration, “Furthermore, we’re expecting fiscal deficits to rise over the next three years and we expect debt to continue to rise over the next three years.” He also cited standoff between republicans and democrats on debt ceiling issue that has hindered the U.S. government from coming up with meaningful solutions to deal with growing fiscal issues, on entitlement programs such as Social Security and Medicare, he said.
Fitch ratings will observe US ability to address long term fiscal solution that addresses entitlement programs and for a willingness to look at the revenue, as well as the spending side, of such programs. This will be important in restoring long term rating to AAA along with a permanent solution on debt-ceiling either by suspending or getting rid of it.
“Given the high level of the debt, given the increasing deficits that we’re expecting, and given the kind of deterioration in governance and unwillingness to really tackle these issues, we don’t think that’s consistent with the AAA anymore,” Francis said. Fitch believes it is more of a governance issue than economical issue.
“This idea that the economy somehow, we skirt a recession and there should not be a downgrade, that’s just not really what we’re looking at,” he said. “We’re looking at a more fundamental picture of the United States, creditworthiness and also kind of what we expect to happen over the next few years.”
See Fitch ratings report here.
But isn’t all factored in? An after event action
There’s nothing new in what Fitch cited as reason for rating downgrade are increase in debt but given the strength of economy it doesn’t seems too much worrisome suggested experts, Fitch said they see it as governance issue and differences between republicans and democrats on various issues including debt ceiling is something hurting the economic outlook, but in my view nothing new in this tussle, it is more of a political issue than a governance issue.
Same is the view of JP Morgan chief executive Jamie Dimon as he described this move as “ridiculous,” saying “it doesn’t really matter” as it was based on factors that were already well known. Market wizard Warren Buffet said that people people should not worry about something and ‘this is one of them’. He said Berkshire bought $10 billion in U.S. Treasurys last Monday. We bought $10 billion in Treasurys this Monday. And the only question for next Monday is whether we will buy $10 billion in 3-month or 6-month” T-bills again.
Buffet said he doesn’t agree with everything Fitch said and though he said the concerns raised are valid but that doesn’t change his view about U.S. Treasurys and the dollar. With this downgrade the most upset party is White House, treasury as they have strongly disagreed with Fitch Ratings’ decision to downgrade the U.S. credit rating.
“The ratings model used by Fitch declined under President Trump and then improved under President Biden, and it defies reality to downgrade the United States at a moment when President Biden has delivered the strongest recovery of any major economy in the world,” said White house press secretary Karine Jean-Pierre but that statement is political in itself and strengthens what Fitch is saying about governance.
Though White House claiming the data on which Fitch acted is outdated sounds valid. According to the U.S. Treasury chief, Fitch’s decision does not change what Americans, investors, and people all around the world already know: that Treasury securities remain the world’s preeminent safe and liquid asset, and that the American economy is fundamentally strong.
Emphasizing that the United States has undergone a historically fast economic recovery from a deep recession over the past few years, Yellen claimed that the unemployment rate is near historic lows, inflation has come down significantly since last summer, and last week’s GDP report shows that the U.S. economy continues to grow.
Yellen said that she and President Joe Biden have been focused on making critical investments in the country’s core economic strength and productive capacity, and are committed to fiscal sustainability. Her claim of fast economic recovery from recession, historically low unemployment and growing GDP is apt and makes the case for US being in strong condition despite debt uncertainty.
Impact on markets
Experts are of the view that it will put a dent on reputation of country, currency but it won’t deter long-term investors from buying securities. Investors won’t sell their stocks looking at Fitch ratings downgrading US to AA+ from AAA, any selloff will be temporary and short lived. Last time S&P downgraded US from it’s highest AAA to second highest AA+(S&P still rates US AA+) causing catastrophic effect on markets, tremors of these selloff were felt around the world.
S&P downgrade of US to AA+ in 2011 and it’s impact on markets
In 2011, rating agency Standard & Poor downgraded US credit rating from AAA to AA+, It was on Friday so investors had a long weekend to think but that didn’t help as main index S&P 500 plummeted 6.5% next Monday. Markets experienced their most volatile week since the global financial meltdown in 2008, and it took another six months for stocks to climb back up to their previous highs. A big winner last time was gold, which rallied and continued to rally afterwards, hitting eventually what would be a long-term high.
But, situation that time was very different as unemployment was very high, above 9%, there was a debt crisis brewing in Euro zone. People were still in fear after 2008 global financial crisis and rate cuts were happening in US by Central banks so they had less weapons to immediately restore faith of markets. Later, Federal reserve chair Ben Bernanke brought operation “twist” to infuse liquidity in the system. The move involved selling $400 billion in short-term Treasuries in exchange for the same amount of longer-term bonds, starting in October and ending in June 2012.
Fitch rating downgrade and S&P downgrade two different phenomena happening at different time, market has past learnings and central banks have plenty of room to adjust as rates are on decade high. Though markets sharply declined on Wednesday, Thursday but are up today(Friday). S&P500 is up 0.72% at 4,534, Dow jones is up 0.74% at 35,476 and tech heavy Nasdaq is up 1.03% to 14,100.
Impact on our(Indian) markets
This rating downgrade of US sovereign credit citing ballooning fiscal deficit and erosion of governance by Fitch won’t deter strong outlook of India, money won’t stop flowing to India due to this re-rating as investors are seeing India as “bullish emerging market” with numerous opportunities. India is a emerging growth story, challenges will come but important thing is how India and its people tackle them.
Conclusion
Fitch in its report believes that financial situation in terms of fiscal deficit for US will keep deteriorating for another 3 years before start improving, it also believes a recession will strike US in 4th quarter of FY24 and 1st quarter of FY25. Fitch ratings though may be right in it’s observation but a lot of all this is factored in by the market. When Fitch kept US on ‘negative watch’ in May on the peak of debt ceiling hike uncertainty, general consensus was there of a rating downgrade so it was not a shock as such.
Markets are also well aware of strength in US economy as unemployment is at it’s lowest level in years and GDP is growing despite macro uncertainties.
Fitch ratings, S&P downgraded US to AA+ but Moody’s still rates US AAA, it is to be known that Fitch, S&P and Moody are largest and most credible credit rating agencies in the world. Click here to read about debt ceiling events.
