Fitch justifies the downgrade of the United States’ rating by pointing out the anticipated decline in fiscal performance over the next three years, a significant and increasing burden of general government debt, and a decline in governance compared to ‘AA’ and ‘AAA’ rated peers, evident in repeated debt limit standoffs and last-minute resolutions over the past two decades.
August arrived with a strong message for the US government, urging them to address their economic governance or face potential consequences. On August 1st, 2023, the renowned credit rating agency, ‘Fitch Ratings,’ downgraded the US Government’s credit rating from AAA to AA+ due to concerns about the nation’s financial condition and mounting debt burden. This significant development is expected to have far-reaching effects on the global market, impacting the US’s standing in the international economy.
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Fitch Ratings
Fitch Ratings is a globally recognized credit rating agency with headquarters in both New York City and London. Investors rely on the agency’s ratings to determine which investments are less likely to default and offer stable returns. Fitch assesses various factors, including the types of debt a company holds and its sensitivity to systemic shifts like interest rates, to assign these ratings. As one of the leading three credit rating agencies worldwide, Fitch holds a prominent position in the global market.
The Fitch rating system is as follows:
Investment grade
- AAA: companies of exceptionally high quality (established, with consistent cash flows)
- AA: still high quality; still has a low default risk.
- A: low default risk; slightly more vulnerable to business or economic factors
- BBB: a low expectation of default; business or economic factors could adversely affect the company
Non-investment grade
- BB: elevated vulnerability to default risk, more susceptible to adverse shifts in business or economic conditions; still financially flexible
- B: degrading financial situation; highly speculative
- CCC: a real possibility of default
- CC: default is a strong probability
- C: default or default-like process has begun
- RD: issuer has defaulted on a payment
- D: defaulted
What is Credit Rating?
Credit rating refers to the assessment of a company’s or government entity’s overall creditworthiness, whether in a general context or regarding specific debts and financial commitments. Independent organizations such as S&P Global, Moody’s, and Fitch Ratings are responsible for providing these ratings. It is important to differentiate credit ratings from credit scores, which are assigned to individuals. The history of credit ratings dates back to the early 20th century, but their significance significantly increased in 1936 when federal banking regulators implemented new regulations to prevent banks from investing in speculative bonds with low credit ratings. This move aimed to reduce the risk of default, which could lead to financial losses and potential bank failures.
Why does Credit Rating matter?
This rating serves as a reference point for investors to assess the level of risk involved in lending money to a government. Your financial history can impact various aspects of your life, including your ability to secure a mortgage, rent an apartment, make significant purchases, obtain loans, rent a car, and even find employment in certain industries. It’s akin to your credit report and rating creating a financial snapshot that presents you to the business world. In this context, the focus is on the government and the country’s economy.
Despite the recent downgrades, the US is typically considered a highly secure investment due to its substantial market size and stable economy. However, this recent downgrade under Biden’s administration is being viewed as another card in the brinkmanship strategy.
Fitch’s Report
Fitch, in response to downgrading the USA’s credit rating, cites concerns over the country’s fiscal deterioration over the next three years, a significant and increasing government debt burden, and a decline in governance when compared to ‘AA’ and ‘AAA-rated peers over the past two decades. According to the rating agency, there has been a steady decline in governance standards, especially regarding fiscal and debt matters, despite a bipartisan agreement in June to suspend the debt limit until January 2025.
Fitch further predicts that the US is likely to experience a mild recession later this year, with the general government deficit expected to rise to 6.3% of GDP in 2023, up from 3.7% in 2022, due to weaker federal revenues, new spending initiatives, and higher interest burden. Additionally, state and local governments are projected to run an overall deficit of 0.6% of GDP this year, following a small surplus of 0.2% of GDP in 2022.
Former US Treasury Secretary Larry Summers criticized Fitch’s decision as “bizarre and inept,” especially when the US economy appears stronger than anticipated. He conveyed this viewpoint in a post on Twitter, now known as X.
US Government’s Response
Janet Yellen, the U.S. Secretary of the Treasury, has expressed strong disagreement with the decision made by the international credit rating agency Fitch Ratings to downgrade the country’s credit rating from “AAA” to “AA+.” Yellen issued a press statement on Tuesday, voicing her dissatisfaction with the agency’s choice to lower the U.S. credit rating.
Alongside several other economists in the U.S., Yellen criticized the agency for utilizing a quantitative rating model that not only significantly declined but also lost relevance in the global competitive evaluation.
Yellen stated, “I firmly disagree with Fitch Ratings’ decision. The change announced today is ‘arbitrary’ and based on outdated data. Fitch’s quantitative rating model saw a significant decline between 2018 and 2020, yet Fitch is making this change now, despite the progress we observe in many of the indicators that Fitch relies on for its decision.”
Yellen VS Fitch
Yellen further affirms that, despite Fitch’s decision, the fact remains unchanged: Treasury securities continue to be the world’s foremost safe and easily tradeable asset, and the American economy remains fundamentally robust. She supported her perspective by highlighting the resilience of the U.S. economy, particularly as the unemployment rate reaches historic lows and inflation experiences a significant decline. Yellen pointed out that the recent report indicates continued growth in the U.S. economy, and she cannot comprehend why the agency chose to lower its rating from “AAA” to “AA+”.Yellen Assures Global.
Investors
“President Biden and I are dedicated to maintaining fiscal sustainability. The recent debt limit legislation incorporated deficit reduction measures exceeding $1 trillion, which has positively impacted our fiscal trajectory.
Going forward, President Biden has presented a budget that aims to decrease the deficit by $2.6 trillion over the next decade, utilizing a balanced approach that supports long-term investments.” – Janet Yellen Yellen emphasized, “The American economy retains its position as the world’s largest and most dynamic economy, boasting the deepest and most liquid financial markets globally.
To enhance this standing, President Biden and I have been focused on making vital investments in our country’s core economic strength and productive capacity.”
