Fitch Ratings downgraded the credit rating of the United States from the highest AAA rating to AA+ this past Tuesday (8/1/23). This decision was based on the expected over 3 years of fiscal deterioration and the erosion of governance standards relative to its ‘AA+’ and ‘AAA’-rated peers.
The Biden administration officials strongly objected to the ratings cut, labeling it as arbitrary and based on outdated data. Treasury Secretary Janet Yellen and White House Press Secretary Karine Jean-Pierre expressed their disagreement with Fitch’s decision.
The Factors Leading to Downgrade
1. A Steady Deterioration in Governance
Fitch expressed concerns about a steady deterioration in governance over the last two decades. This includes a lack of fiscal medium-term framework and frequent political standoffs over the debt limit. The agency believes that these factors have eroded confidence in the country’s fiscal management.
2. Rising General Government Deficits
The expected rise is 6.3% of its GDP this year from 3.7% last year, coupled with cyclically weaker federal revenues and new spending initiatives, contributed to the downgrade. Local governments and State are also projected to run deficits, adding to the fiscal challenges.
3. Growing General Government Debt Burden
The debt to GDP ratio, which had reduced slightly from pandemic highs, is still significantly higher than its pre-pandemic levels. Fitch projects the debt ratio to rise further, reaching 118.4% by 2025, leading to the United States fiscal position vulnerable to upcoming future economic shocks.
4. Medium-term Fiscal Challenges
Fitch highlighted challenges related to an aging population, rising healthcare costs, and higher interest rates, which will increase the interest service burden. Without timely corrective measures, the Social Security and Medicare funds are expected to be depleted, posing additional challenges for the fiscal trajectory.
Implications of the Downgrade
The downgrade from AAA to AA+ has several potential consequences for the U.S. economy:
1. Impact on Mortgage Rates
The downgrade may cause investors to sell U.S. Treasuries, leading to higher yields. This, in turn, could result in increased mortgage rates for Americans looking to buy homes.
2. Influence on Global Contracts
As the U.S. debt has long been considered a safe haven, the downgrade may affect various contracts and agreements worldwide, possibly leading to adjustments in interest rates and terms.
3. Investor Reactions
Investors might reevaluate their portfolios and risk assessments due to the change in the U.S. credit rating, potentially affecting the overall stability of financial markets.
Fitch’s decision to downgrade the U.S. credit rating to AA+ signals concerns over the country’s fiscal management and governance standards. The downgrade could have implications on mortgage rates, global contracts, and investor confidence. While the Biden administration disputes the decision, the long-term effects remain to be seen.
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