Fitch lowered the credit rating of the U.S. from AAA to AA+. The downgrade should do little to derail confidence in the country, even if it is hitting markets, and appears to have more to do with Washington than economics.
At the fore of Fitch’s rationale is what it calls an erosion of governance. “There has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025. The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management,” the rating firm said.
Political jockeying over the debt ceiling has become the focus of international attention, and not in a good way. The U.S. may have the world’s deepest and widest capital markets, but Congressional consensus on fiscal policy looks increasingly chaotic.
The White House said it disagreed with the downgrade. Treasury Secretary Janet Yellen said the move was based on outdated data that ignored the resiliency of the economy.
Indeed, economic growth has kept up at a roaring pace despite the highest interest rates in a generation. Gross-domestic product clocked in at an expectation-defying 2.4% annual rate in the second quarter. Inflation is declining faster than expected too, with the latest round of consumer price index data showing prices rising 3% year over year in June. And when the jobs report is released on Friday, it is expected to show unemployment remains near a half-century low at 3.6%, and that jobs growth is healthy while moderate enough to temper inflation concerns.
These aren’t the symptoms of a country due for a credit downgrade. Still, the strength of a country’s economy isn’t the only factor to consider in its credit rating.
“It’s true that this move by Fitch is somewhat based on outdated data, especially with the trajectory of inflation now in at a more favorable gradient,” said Sophie Lund-Yates, an analyst at broker Hargreaves Lansdown.
Nonetheless, the move still hit markets. The
Dow Jones Industrial Average,
S&P 500,
and
Nasdaq Composite
were all in the red in Wednesday trading. The
10-year Treasury yield
rose 0.029 percentage point to 4.077%, its highest yield since November.
While stocks have lurched lower today, the damage doesn’t look terrible. Yes, a credit rating downgrade is serious, but the U.S. has gone through this once before. And the economy is in a better position now than it was the last time this happened. Plus, this won’t stop global investors from buying U.S. Treasuries. The dollar remains the world’s reserve currency and hit a 20-year high last year.
S&P, one of the three major credit rating firms, downgraded U.S. debt on Aug. 5, 2011, after another major debt ceiling battle. On Aug. 8—the first trading day after the S&P downgrade—the S&P 500 lost almost 7% in what became known as Black Monday. The benchmark index would lose 5.7% that month, and another 7.2% in September.
At the time, Wall Street was limping out of the 2008-09 financial crisis and unemployment remained high. Not only did that year see a bitter debt ceiling battle, but also developments in the heady days of Europe’s debt crisis.
“Obviously S&P being the first to downgrade 12 years ago was far bigger news and has allowed investors to adjust for the most important bond market in the world not being a pure AAA anymore but it’s still a big decision [from Fitch],” said Jim Reid, a strategist at Deutsche Bank.
Investors shouldn’t forget the lessons of 2011, but they also shouldn’t forget a simple fact: It has been a great year for stocks. The S&P 500 is up some 18% this year. Even one of Wall Street’s biggest pessimists, Morgan Stanley’s chief U.S. equity strategist, is starting to change his tune.
Write to Jack Denton at [email protected]
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