The U.S. Government Credit Downgrade and Its Impact
You probably saw the headlines about Fitch Ratings downgrading the U.S. government from AAA to AA+ on August 1. What does that mean for your investments? The impact should be minimal.
The three main credit rating agencies are S&P Global Ratings, Moody's Investor Services, and Fitch Ratings. The highest rating an agency can give to an issuer of debt is AAA. When the U.S. government issues debt, it is called U.S. Treasuries. U.S. Treasuries are widely considered the safest investment and the U.S. government has enjoyed triple A ratings. But in 2011, S&P Global Ratings lowered the rating for the U.S. government for the first time in history after a U.S. debt-ceiling standoff. On August 1, 2023, Fitch Ratings lowered the rating as well following a similar standoff and last-minute solution. Moody’s Investor Services has not yet lowered the U.S. government’s rating.
Despite Treasury Secretary Yellen's recent claim that the U.S. government never defaulted on its debt, it did in fact default on obligations four times (in 1862, 1933, 1968, and 1971). Since 2020, nine separate sovereign countries defaulted on their obligations at least once, including Argentina, Ecuador, Suriname, and Ukraine.
Fitch Ratings listed three reasons for the U.S. government downgrade:
Expected fiscal deterioration over the next three years
A high and growing general government debt burden
The erosion of governance relative to ‘AA' and ‘AAA' rated peers
With increasing interest rates, the growing U.S. government debt will be more expensive to service. Politicians’ willingness to foster a fear of possible default until the last minute has not helped build confidence in the government’s ability to service its debt.
However, despite these standoffs and the lower ratings, U.S. Treasuries continue to be considered the lowest risk investment worldwide. Despite the downgrade, Fitch Ratings kept its country ceiling for the U.S. at AAA. If the U.S. government were to run out of money, it could always print more to meet its obligations. But if it prints too much money, it will stoke inflation.
Sometimes, a downgrade of a security can trigger a selloff because some investment groups have to maintain a certain rating average among their holdings. But that should not have a significant impact on U.S. Treasuries because most investment groups refer directly to Treasuries in their investment policies and not credit ratings.
When S&P Global Ratings lowered the U.S. government’s rating in 2011, demand for U.S. Treasuries actually increased. This year’s downgrade did not come as a surprise and was not based on any newly available information. Regardless, questions about the government’s ability to service its debt will continue to grow over the coming years. The long-term effects of the downgrade and the lending environment will likely be a weaker dollar and higher yields. To address the rising cost of servicing its debt, the U.S. Treasury announced that it will increase the amount of Treasuries it sells which could further increase yields.
We continue to see U.S. Treasuries as a safe haven and are taking advantage of the higher yields. Even though a U.S. government default is unlikely, headlines about the debt ceiling will continue to affect investor sentiment. The downgrade will likely make debt and deficit spending a focus of the election next year.
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