US rating downgrade bad for global markets

Fitch Ratings on tuesday downgraded the US government’s creditworthiness to AA+ from AAA, citing expected fiscal deterioration over the next three years, high and growing government debt, and the erosion of governance. the move came 12 years after Standard & Poor’s stripped the US its triple-A rating and downgraded it to AA+, an action it never reversed.

US stock futures tumbled after the downgrade, while markets in Europe also sank. Hong Kong, Tokyo, Australia, South Korea and other Asian markets fell by up to 2 percent following the downgrade by Fitch. Stocks of tech firms that depend on the US and Western markets for business were impacted the most.

The AAA rating is the highest credit rating that may be assigned to an issuer’s bonds. It represents a virtual guarantee that an issuer will never run out of money to pay its debts. The AA+ rating is one level below AAA, meaning the issuer no longer has what the ratings firms call the “highest credit quality.”

The global credit rating industry is highly concentrated, with three agencies— Moody’s, Standard & Poor’s, and Fitch—controlling nearly the entire market. The big three hold a collective global market share of “roughly 95 percent,” with Moody’s and Standard & Poor’s having approximately 40 percent each, and Fitch around 15 percent.

When governments issue bonds, these ratings companies help investors determine their investment decisions. Bonds that receive higher ratings from these agencies are considered “investment grade” and are unlikely to default. These bonds typically pay lower rates than riskier debt, but are considered much safer. In general, when an issuer of debt has its credit rating downgraded, that often means it has to pay a higher interest rate to compensate for the potentially higher risk of default it poses.

While the AA+ rating is considered a good ranking for investment-grade debt, there is a reputational damage involved because the downgrade removed the US from a small group of countries that still maintain the top-notch rating from all three major agencies. The remaining AAA-rated countries are Australia, Denmark, Germany, Luxembourg, Netherlands, Norway, Singapore, Sweden and Switzerland.

The Biden administration reacted angrily to the rating downgrade. Treasury Secretary Janet Yellen said Fitch’s “flawed assessment is based on outdated data and fails to reflect improvements across a range of indicators, including those related to governance, that we’ve seen over the past two and a half years.”

Yellen added: “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.”

Douglas Holtz-Eakin, president of the American Action Forum and former director of the Congressional Budget Office, said the Biden administration’s response has been to shoot the messenger by arguing “Fitch is playing politics.” He said that Fitch’s decision was the right one, given that the US has high and rising debt, and the government has no plan to address the growing budget deficit. “This is about a fundamental mismatch over the long term between our spending growth and our revenue capabilities,” he said.

Pundits said there is little chance the Fitch move will change the US policy outlook given the partisan divide between Democrats and Republicans. Amid the fiscal bickering, Congress appears to be on track to trigger a government shutdown on October 1 because it is not expected to pass the 12 appropriations bills that fund government operations before the start of the new fiscal year.

Political polarization has clearly reached a precarious level in the US. Partisanship is preventing the forging of realistic action to address the specific fiscal challenges Fitch mentioned in its downgrade.

In the long term, experts said the US rating downgrade could have potentially adverse consequences for the broader global economy. This is because US government debt, in the form of Treasury securities, underpins not just the US economy but also the global economy. This means US government debt is considered one of the safest interest-bearing investments in the world, and a global benchmark for interest rates.

Experts said the US is perilously on an unsustainable fiscal path, and policymakers should take the downgrade seriously. It should serve as a powerful signal to policymakers that they need to get their fiscal house in order because of the underlying problems the rating firm identified and the negative impact a lower credit rating could have on the US economy.