Fitch Gets Bored in August, Downgrades US Citing Old News

Welcome to August, that time when politicians go on vacation, meaningful news is thin and headlines get a bit silly. It is also the time when your friendly MarketMinder editors have occasionally struggled to find things to write about, so we guess we can empathize with the fine folks at Fitch, who conjured a downgrade of the US’s AAA credit rating to AA+ Tuesday afternoon. The announcement hit after markets closed, so we will have to wait a tick to see the knee-jerk sentiment impact. However, we don’t think this means one iota for stocks and bonds over any meaningful period.

When Standard & Poor’s downgraded the US in 2011, becoming the first ratings agency to relieve Uncle Sam of his top, AAA credit rating, it happened in the throes of the eurozone’s debt crisis and mere days after an epic debt ceiling standoff. The resolution, which included the infamous sequestration budget cuts, wasn’t enough to convince S&P of the US Treasury’s creditworthiness—the raters said the standoff itself and politicians’ increasing infatuation with using the debt ceiling as a bargaining chip warranted a downgrade. (They also cited some numbers, but there was a rather large math error.) It all came amid a sharp bull market correction, adding to investors’ furor. It also preceded a drop in US government bond yields and several years of lovely stock returns, so investors pretty quickly got over it.

This time, there is scant news. The last debt ceiling battle was one of the least colorful in recent memory. It had all the requisite false warnings of default, but no one’s heart seemed to be in the hyperbole, and negotiations mostly plodded along until the bipartisan deal was sealed earlier than usual. It also wrapped up nearly two months ago. We did get the Congressional Budget Office’s (CBO’s) updated fiscal forecasts in late June, but they mostly confirmed prior projections.

A lot of the immediate reaction seems to be surprise that Fitch followed through on their earlier, springtime threat. But as our Elisabeth Dellinger and Todd Bliman noted in a June post-squabble wrap-up, “Yet despite the broad deal passed with ample time to spare by historical standards, Fitch could still downgrade. … And, of course, ratings agencies are comprised of people (we think)—not a market function. You can’t presume they will behave in a fashion that may seem linear and logical.”

Still, when news of Fitch’s downgrade hit the wires, we were eager to see their reasoning. And it turned out to be … a potpourri of standard debt fears. It cited the debt ceiling standoffs, of course, as well as the CBO forecasts, the 2017 tax cuts, higher government spending, Social Security and Medicare funding and Fitch’s own US economic forecasts (for a late 2023/early 2024 recession, natch). Most colorful was its judgment of “Erosion of Governance,” which amounted to those darned US politicians don’t do what we want them to do, boo hiss. At least that is our translation of “The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management. In addition, the government lacks a medium-term fiscal framework, unlike most peers, and has a complex budgeting process.”^[i]

Here is the thing. Credit ratings are opinions, and Fitch is entitled to theirs—just as S&P was entitled to its own views, which it eventually defended as “puffery.”^[ii] But opinions aren’t predictive, and we don’t think the downgrade represents an actual deterioration in credit conditions. You see, none of the stuff cited in the rationale is new. Those CBO forecasts have painted a dreary picture with straight-line math and strange assumptions for years. Social Security and Medicare steal headlines every year when the Trustees’ Report shows updated projections for depletion of the trust funds. Politicians have been using the debt ceiling as a wedge issue for decades, and budget bickering is the norm. Through it all, the US Treasury has never defaulted. Markets saw this when S&P downgraded the US in 2011, affirming their confidence in the US Treasury’s full faith and credit by sending bond yields lower.

If debt were actually a problem, markets would likely show it long before credit raters reported on it. This downgrade may be an extreme example, but all raters’ decisions simply collate widely known information and opinions. This is why they rarely move markets much, as Exhibit 1 illustrates.

Exhibit 1: AAA Downgrades Don’t Skyrocket Yields

Source: Fitch Ratings, S&P Global Ratings, FactSet, Global Financial Data, Inc., as of 5/25/2023. Change in issuing nations’ 10-year bond yields 60 days before and after downgrades.

Markets are forward-looking, pre-pricing all of these things before they wind up in backward-looking reports. Considering US Treasurys have mostly followed the global trend, we don’t think markets are signaling undue risk now. If they seem fine with everything in Fitch’s report, investors should be, too.