Fitch Ratings has reduced the US government’s credit rating from AAA to AA+, citing worries about the Biden Administration’s capacity to manage the country’s finances and debt loads.
The decision is the result of huge inflation in expenditure by the Biden administration, which will ultimately cost US taxpayers. A weaker credit rating might raise borrowing costs for the US government over time, implying higher taxes to pay for the growing debt.
On May 24, Fitch warned the Biden administration that record government debt and a struggle over the debt ceiling might lead the country’s triple-A rating to fall.
Another element influencing Fitch’s judgement is the expectation that the US economy would enter a recession in the final three months of this year and early next year.
The Federal Reserve’s economists made a similar projection this spring, but then reversed it in July, saying growth would slow but a recession was unlikely.
White House and the Fitch Ratings Downgrade
The downgrade of Finch elicited a strong response from the Biden White House and caught investors off guard. Traders’ immediate reaction was to flee to safe-haven assets such as government bonds and the dollar.
Fitch downgraded the US from AAA to AA+, citing budgetary deterioration over the next three years and recurrent last-minute debt ceiling talks that jeopardise the government’s ability to pay its obligations.
Fitch first raised the prospect of a downgrade in May, then reiterated its position in June after the debt limit crisis was overcome, saying it planned to complete the study in the third quarter of this year.
With the downgrading, it becomes the second major rating agency, after Standard & Poor’s, to revoke the US’s triple-A rating.
Fitch’s decision comes two months after Democratic President Joe Biden and the Republican-controlled House of Representatives agreed a debt ceiling agreement that raised the government’s $31.4 trillion borrowing limit, putting an end to months of political wrangling.
Deterioration in governance standards
“In Fitch’s opinion, there has been a steady deterioration in governance standards over the last 20 years, including on fiscal and debt issues, despite the June bipartisan agreement to suspend the debt limit until January 2025,” the rating agency said in a statement.
Fitch’s downgrading, according to U.S. Treasury Secretary Janet Yellen, was “arbitrary and based on outdated data.”
The White House expressed a similar sentiment, stating that it “strongly disagrees with this decision.”
“To downgrade the United States at a time when President Biden has delivered the strongest recovery of any major economy in the world defies reality,” said White House press secretary Karine Jean-Pierre.
The United States’ debt has long been regarded the safest of safe havens, but Tuesday’s rating downgrade implies it has lost some of its lustre. The downgrade could have ramifications for anything from mortgage rates in the United States to contracts signed all over the world.
The action may encourage investors to sell US Treasuries, resulting in a rise in yields that serve as benchmarks for interest rates on other loans.
While the US stock markets ignored the downgrading, domestic stock markets fell more than 1% on Wednesday as investors were concerned following Fitch Ratings’ reduction of the US credit rating and ongoing withdrawals from foreign portfolio investors.
The BSE Sensex fell 676.53 points, or 1.02 percent, to 65,782.78 at the closing. During intraday trading, the 30-share index slid 1,028 points. The Nifty concluded the day at 19,526.55, down 207 points, or 1.05 percent.
Asian Markets Down
Despite the Fitch downgrade, the Dow Jones industrial average rose 0.20 percent on Tuesday (August 1). Dow Futures, on the other hand, are down 0.37 percent on Wednesday.
On the other hand, the Sensex plummeted by more than 1% to below 66,000 due to negative global cues. Following Fitch’s downgrading, markets in Hong Kong, Tokyo, Australia, Korea, and other Asian countries plummeted by up to 2%. Stocks of technology companies that rely on the US and western markets for revenue suffered the most.
However, US investors are concerned that overseas holders may dump US Treasuries. Selling US Treasuries may cause US Treasury rates to rise further, limiting stock market advances.
Fitch warned of a probable downgrade in May, before an agreement on the debt ceiling is achieved. The timing, on the other hand, may have startled the market. Whatever happens in the United States has an effect on the global market.
According to Fitch, tighter lending conditions, decreasing business investment, and a slowdown in consumption will push the US economy into a mild recession in Q4 of FY23 and Q1 of 2024. According to the agency, yearly real GDP growth in the United States would decrease to 1.2% this year from 2.1% in 2022, with overall growth of only 0.5% in 2024.
This is bad news for other countries and global investors because the United States has the world’s largest economy and the performance of other economies is dependent on the United States to some extent.