Ratings agency Fitch’s decision to downgrade the US government’s credit rating is “purely political”, according to some senior investment professionals, who believe the country’s economy remains resilient. Others, however, warn the stereotypically ‘safe haven’ asset class is less appealing than it once was.
In the early hours of yesterday morning (1 August), Fitch moved US debt’s ‘AAA’ rating down to ‘AA plus’, after citing concerns over the country’s ever-growing debt burden.
The demerit reflects the “expected fiscal deterioration” over the next three years and a “high and growing general government debt”, according to the ratings agency.
Fitch also said it had witnessed a general erosion of governance over the last two decades, leading to repeated debt limit crises and last-minute resolutions, such as the one seen earlier this year.
In June, the US government lifted the debt ceiling to $31.4trn (£24.6trn) following a protracted political battle which saw the country move days away from a default.
See also: Markets have no margin for error as US debt ceiling wrangle rolls on
Purely on political grounds
US Treasury Secretary Janet Yellen criticised the move, labelling the downgrade “arbitrary” and based on “outdated data” from the period 2018 to 2020.
Karsten Junius, chief economist at J Safra Sarasin, said that, given the frequency of debt ceiling standoffs, he understands why the downgrade took place as the probability of a default is not zero.
“Instead, [the risk of default] increases the more partisan policy-making becomes. Also, considering that the latest debt ceiling episode captivated bond markets for weeks, it would be difficult to argue that financial markets would attach a zero risk to the default probability of the US,” he said.
“We would stress, however, that this is purely on political, not economic grounds. Despite higher interest rates, the US economy is currently showing once again how resilient it is. It is growing more strongly and stable than most other countries and the chances of a soft-landing appear higher than we assumed at the beginning of the year.
“Therefore, we also understand Yellen’s criticism of the rating decision that is not taking into account the latest economic data. Still, we note that debt is on an increasing path and it is questionable if in the current environment it would be politically feasible to bring it back to more sustainable levels.”
‘No immediate bond market impact’
Despite the credit drawdown, it is not anticipated to immediately impact the bond market due to the current stability of the US economy.
Junius added: “It will remain the most liquid and, in times of crisis, the most sought after market globally. However, we also note that Fitch is the second big rating agency that is not allocating the highest rating to US government debt anymore.
“Together with the geopolitical trends and considerations we could imagine that over the course of the next few years some countries might find US government bonds a less appealing asset to hold most of its currency reserves in than it used to be.”
However, Jupiter Asset Management fixed income investment manager Harry Richards believes that, longer term, yields on US treasuries will fall.
He said: “We expect a weaker US economy, and we think that is ultimately going to have repercussions on the path for monetary policy, leading to lower yields on US Treasuries.
“While we acknowledge external credit ratings, our views on default risk are based on our own research and thinking. In our opinion the US remains extremely unlikely to default and given where rates have moved, we believe treasuries offer great value at these levels given their ability to provide protection in an economic downturn.”
Jeroen Blokland, founder and head of research at True Insights, pointed out that often ratings agencies are criticised for “doing too little too late”.
“But with the massive fiscal deficit looming now that interest rates have spiked, it would be somewhat odd not to pay attention to this, even though the US treasury market will likely remain the bond market of last resort in the foreseeable future.”
