Fitch’s move was not completely unpredictable and it comes after warnings of a possible downgrade in May
Fitch, the top rating agency downgraded the United States credit ratings citing a decline in standards of governance and rising debt. The credit rate dropping from AAA to AA+ by Fitch had invited an angry response from the White House. The lower credit rating provides investors with a lead of risks associated with investing in the debt of a particular country, which could increase the borrowing costs over time for the government. In June, Republicans and Democrats reached an agreement to avoid a debt default by raising the $31.4 trillion borrowing limit.
Fitch stated that growing concerns of polarization around tax policy and spending caused repeated “debt limit standoffs” and last-minute resolutions leading to the downgrading of ratings. The debt default was avoided came after Republicans used the issue as an instrument to pressure President Joe Biden into reducing the spending for Democratic policy priorities.
Fitch in a statement on Tuesday mentioned that the rating downgrade shows the expected fiscal downgrade over the next three years, a high government debt burden, and “the erosion of governance”. “In Fitch’s view, 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,” added the rating agency. Washington’s limited progress and lack of a medium-term fiscal framework in issues arising from increasing social security and medical bills due to an aging population.
Fitch’s move, however, was not completely unpredictable and it comes after warnings of a possible downgrade in May. This downgrade also marks the second cut to the US’s credit rating in its history. In 2011, Standard and Poor downgraded the US rating from AAA after a prolonged impasse over the debt ceiling. This also raised the borrowing costs that year by an estimated $1.3 billion. Janet Yellen, Treasury Secretary, stated that the decision was arbitrary and was based on old information.
“Many of these measures, including those related to governance, have shown improvement over the course of this Administration, with the passage of bipartisan legislation to address the debt limit, investment in infrastructure and make other investments in America’s competitiveness,” stated Yellen. She also added that Fitch’s decision does not change what Americans and investors already know and Treasury securities remain as the preeminent safe and liquid asset. Along with this, she also added that the American economy is fundamentally strong.
A AAA in Fitch Ratings showcases the best, and an AA+ rating signifies high quality. The credit rating of the United States has been downgraded to AA+ with a stable outlook, meaning the creditworthiness is still strong. This downgrade will have an impact on the global markets. The US markets, however, barely reacted to the downgrade on Tuesday in after-hours trading and the Treasuries were stable. Eventually, there might be reactions, and on Wednesday, the US stock futures were pointing to a weaker option. The global markets stumbled at night.
What Might Happen?
Taking a look back at history might give a small peek into what might happen in the markets following the downgrade. In 2011, Standard and Poor downgraded the US for the first time in history. On the first day after the downgrade, the S&P plunged by 6.5%. Since the global financial meltdown, that would be the first time the markets have experienced their most volatile week. It took nearly six months for the stocks to climb back to their previous heights.
Effect on the Global Markets
Hong Kong’s Hang Seng Index (HSI) closed down 2.5% and Japan’s benchmark Nikkei 225 (N225) had its worst day of the year so far ending down at 2.5% after Fitch downgraded the US to AA+ from AAA. European region performed better comparatively but the benchmark Stoxx 600 index fell 1.4%. France’s CAC (CAC40) 40 fell 1.2% and Germany’s DAX (DAX) plunged 1.4%. London’s FTSE 100 also declined 1.5%, which is a two-week low.