Sentiment on Wall Street flashed red as credit rating agency Fitch downgraded the U.S. long-term foreign currency rating to AA+. Previously, the nation held a pristine rating of AAA. Primarily, the negative reassessment focuses on “the expected fiscal deterioration over the next three years,” a matter worsened by increasingly bitter political infighting. Following the Fitch downgrade, the benchmark S&P 500 slipped more than 1% and the Nasdaq over 2%.
Per the agency’s official statement, a “steady deterioration” in standards of governance during the past two decades imposes a dark cloud as policymakers struggle to navigate the extraordinarily difficult post-pandemic environment. Specifically, “[t]he repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management.” As well, the combination of economic shocks and initiatives involving tax cuts and spending programs spiked the overall debt load.
In addition, Fitch took into account the Federal Reserve’s efforts in combating historically high inflation into account regarding its latest credit rating decision. “While headline inflation fell to 3% in June, core PCE inflation, the Fed’s key price index, remained stubbornly high at 4.1% yoy,” wrote the agency. As a result, this framework will likely preclude benchmark interest rate cuts until March of next year.
In a possible reality check, the Fitch downgrade also incorporated recession risks. Based on the aforementioned tighter credit condition and a projected consumer spending slowdown, the U.S. economy may slip into a mild recession in the fourth quarter of 2023 and Q1 of 2024.
Criticism Spikes Following Credit Rating Downgrade
As The Wall Street Journal pointed out, the Fitch downgrade represents the first by a major credit rating agency in more than a decade. In theory, the unfavorable reassessment clouds the outlook for the global market for Treasurys, which stands at $25 trillion.
Indeed, the WSJ states that “America’s reputation for reliably making good on its IOUs has cast Treasury bonds in an indispensable role in global markets: a safe-haven security offering nearly risk-free returns.”
Moreover, a major credit rating isn’t just a matter of semantics. “Treasurys serve as a critical benchmark for returns on stocks and other bonds, because investors generally demand greater yields on any other securities that they buy.”
Therefore, the subsequent criticism of the credit rating downgrade likely failed to catch market observers by surprise. In particular, Treasury Secretary Janet Yellen blasted the Fitch downgrade as “arbitrary.” Yellen noted that the agency demonstrated deteriorating U.S. governance since 2018 but didn’t say anything until now. “The American economy is fundamentally strong,” she emphasized.
The New York Times op-ed writer and Nobel laureate Paul Krugman chimed in, calling the credit rating decision “bizarre.” Also, former Secretary of the Treasury Larry Summers, in an interview with Bloomberg, stated, “I can’t imagine any serious credit analyst is going to give this weight.”
Does a Fitch Downgrade Matter?
On paper, the credit rating falling appears rather ominous. However, Axios — while not dismissing the relevant concerns leading to the decision — stated that the Fitch downgrade is “largely symbolic.”
Also, it’s important to remember that credit rating agencies don’t always issue accurate prognostications. For instance, in October of last year, Fitch stated that it expected a mild recession to materialize in Q2 2023. However, CNN recently reported that the economy picked up steam in Q2 “despite punishing rate hikes and still-high inflation.”
On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
