You may have seen that on Tuesday night, rating firm Fitch downgraded the United States credit rating from AAA to AA+. I have seen and heard the move described as puzzling, ridiculous, and perplexing – and those are among the nicest terms used.
There was a muted market reaction to the news on Wednesday, largely because the rating change won’t really have an impact. US Treasury bonds are still overwhelmingly likely to be paid on time and – because the US dollar is still the global reserve currency – remain popular to bond buyers both here in the US and around the globe as well.
While the downgrade itself doesn’t matter, the three reasons that Fitch cited in their decision need a deeper breakdown.
Rising General Government Deficits – Fitch expects the US deficit to rise to 6.3% of GDP (Gross Domestic Product) in 2023 and higher in subsequent years, “driven by weak 2024 GDP growth.” Fitch is projecting that the US will enter a recession in late-2023.
My thoughts – So far in 2023, US GDP has come in much stronger than projected and future predictions have been revised upwards. While the US entering a recession was nearly the consensus at the start of the year, consumer strength has caused many analysts to change their tune. High government debt is an issue to be sure, but in my mind the end result is likely to be inflation, not the inability of the government – who owns the printing press – to pay off their debts.
Medium-term Fiscal Challenges Unaddressed – Fitch lumps several different risks under this heading. They include: interest cost on US debt will rise to 3.6% of GDP in 10 years, mandatory spending on Medicare and Social Security will rise to 1.5% of GDP by 2033, Social Security will be depleted in 10 years and Medicare Part A will be depleted by 2035.
My thoughts – Will Social Security and Medicare be exactly the same in 10 years as they are now? Highly unlikely. Will they still exist? Almost certainly. Interest costs on US debt are dependent on several factors, not the least of which is the US Federal Reserve. By the Fed’s own projections, the Fed Funds rate is currently 2-3% above what they believe the long-term average will be. Future interest costs will most likely be higher than what we got used to during the 2010s, but should realize the benefit of lower rates in the future.
Erosion of Governance – This is the most controversial piece of Fitch’s decision as it’s not driven by data, but rather their view of how the political sausage is made. In their view “there has been a steady deterioration in standards of governance over the last 20 years…” They specifically cite debt-ceiling political standoffs, the lack of a medium-term fiscal framework, and a complex budgeting process.
My thoughts – Those factors are all true – and have been for some time. Why Fitch chose now to include those factors into a ratings downgrade is the subject of significant debate. Immediately after the announcement, press releases began flying from the administration calling this action “politically motivated”. While the timing is curious, trying to guess at someone’s – or, as is likely here, a group of someones – reasoning is a futile effort. Doing so obscures the real issues, as far as I’m concerned.
Lest you think it’s all bad news, Fitch did comment on the US’s “Exceptional Strengths”:
“Several structural strengths underpin the United States' ratings. These include its large, advanced, well-diversified and high-income economy, supported by a dynamic business environment. Critically, the U.S. dollar is the world's preeminent reserve currency, which gives the government extraordinary financing flexibility.”
In my opinion, while there certainly are issues at play, the odds of a debt default by the US Government – what the ratings by Fitch and other agencies are supposed to measure – remains extremely low. That’s why I think that whether that means the US is rated AAA, AA+, or 5-stars, the rating itself just doesn’t matter.
Photo by kaleb tapp on Unsplash