Fitch's downgrade of U.S. debt unlikely to have much economic impact — for now

Published Wed, Aug 2 20231:41 PM EDTUpdated Wed, Aug 2 20233:19 PM EDT

Twelve years ago, Standard & Poor's downgraded U.S. debt, raising substantial concerns about the creditworthiness of the world's largest economy and creating a momentary crisis of confidence both on Main Street and Wall Street. A similar move Tuesday from Fitch Ratings seems unlikely to create the same ripples. While financial markets on Wednesday took a break from their monster rally of 2023, economists largely expect the impact on the economy to be minimal. Some even questioned the timing of Fitch's action, saying it seems to come after the biggest scare to whether the U.S. would meet its debt obligations has passed. Mohamed El-Erian , chief economic advisor at Allianz, called it a "strange move" and said he was "puzzled by many aspects of this announcement, as well as by the timing." "I suspect I won't be the only one. The vast majority of economists and market analysts looking at this are likely to be equally perplexed by the reasons cited and the timing," El-Erian posted on X, the company formerly known as Twitter. Overall, this announcement is much more likely to be dismissed than have a lasting disruptive impact on the US #economy and #markets." In announcing the downgrade to AA+ from AAA, Fitch said the move reflected "the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance" relative to high-rated global peers. It also cited the battles that warring congressional factions have had over the debt ceiling as well as budget standoffs. 'Something we should take very seriously' However, the move comes nearly two months after Congress agreed to raise the debt ceiling. Monetary authorities also seem to be making progress against inflation , and economists slowly are lifting their most pessimistic predictions for where growth is heading, with some now thinking the U.S. can avoid a recession. Thus, the Fitch downgrade is unlikely "to have a very, very strong impact," said Veronique de Rugy, senior research fellow at the Mercatus Center, a libertarian think tank at George Mason University. "But I do think that this is something we should take very seriously, if only because there's no going around the fact that our debt is exploding," de Rugy said. "In the next 30 years in particular, the Treasury will have to convince investors to buy something like four times more debt than in our entire history, and a downgrade is not great for that." Indeed, the Treasury Department's borrowing needs for the third quarter of just over $1 trillion were far more than the market had expected. That borrowing is to feed a national debt that has exploded to $32.6 trillion, some 40% higher than it was prior to the Covid pandemic. Borrowing costs have been rising as the Federal Reserve has raised interest rates , with the average rate on total marketable debt rising to nearly 2.8%, close to double what it was before rate hikes began in March 2022. "In order to find a solution to this problem, you're going to have to have bipartisan efforts and and a lot of open mindedness on both sides of the aisle," de Rugy said. "And there's none of that right now." 'No new fiscal information' However, that's likely a war that will be fought another day, and for now Wall Street remains fairly sanguine about the impact from Fitch's cut. Goldman Sachs said the narrative around the move "contains no new fiscal information" and puts forth projections that are around consensus or those from the Congressional Budget Office. Goldman also said it does not see a meaningful impact on holders of Treasurys or other government-sponsored or municipal debt. Likewise, Capital Economics called it "a little strange to be downgrading the US. at a time when the economy now appears poised to pull off the seemingly impossible trick of bringing inflation back to target without triggering a recession." However, Capital noted that much will depend on whether that soft-landing scenario happens and the Fed can start easing monetary policy. "If we're right and inflation continues to ease, the Fed will be cutting rates again by next year, bringing the Federal government's borrowing costs down," the firm said in a client note. "But if we're wrong and the Fed is forced to keep the nominal interest rate above the rate of nominal GDP growth for an extended period, then the debt dynamics could quickly become unsustainable." There's also the question of whether other ratings agencies will follow suit. An S & P spokesman said the firm has not released any further comment on the debt beyond its March affirmation of the U.S. credit rating. Moody's Investors Service did not immediately return a request for comment.