Markets hit the skids on Wednesday after Fitch Ratings downgraded its rating on U.S. debt to AA+ on Tuesday evening — one notch below the agency's highest rating of AAA.
The Nasdaq Composite suffered its worth day since February, shedding 2.17%. The S&P 500 surrendered 1.38%, and the Dow Jones Industrial average slid 0.98%.
The decision from Fitch appears to have more to do with Washington than it does with Wall Street. "The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management," the rating firm said in a press release.
In a vacuum, the announcement coupled with the downdraft in stock prices should raise alarm bells for investors. In historical context, though, this week's downgrade is less of a big deal than it seems, experts say.
"The average investor shouldn't worry here," says Ryan Detrick, chief market strategist at Carson Group. "This happened in 2011, so it isn't nearly the same shock as it was back then."
Here's everything you need to know about the downgrade.
Who is Fitch again?
When companies or governments issue bonds, investors turn to three major ratings companies — Fitch, Moody's and Standard & Poor's — to determine how likely these entities are to default on their debt.
Bonds that receive higher ratings from these agencies are considered "investment grade" and are unlikely to default. These bonds typically pay lower rates than riskier debt, but are considered much safer. The AAA rating is the best of the best and represents a virtual guarantee that an issuer will never run out of money to pay its debts.
Bonds with below-investment grade ratings are known as high-yield or "junk" bonds. In exchange for the heightened risk of default, these debts offer higher yields to entice investors. U.S. debt is miles away from that territory — Fitch's downgrade represents a fall from the very peak of creditworthiness to one notch below.
Has Fitch done this before?
Nope, but S&P has. In August 2011, following a period of partisan squabbling over raising the debt ceiling (sound familiar?) the rating agency dinged Uncle Sam's once perfect credit rating. On August 5, the first trading day after the announcement, the S&P 500 fell by almost 7%.
"This time, the reaction was much more muted," says Jon Maier, chief investment officer at Global X ETFs. "The market is mostly shrugging it off."
That makes sense on at least one front: S&P hasn't restored the AAA rating the U.S. relinquished in 2011. In other words, Fitch put their rating in line with where S&P already was.
"In some ways, the S&P downgrade echoes the current downgrade from Fitch," Sam Millette, fixed income strategist for the Commonwealth Financial Network, wrote in a recent note. "Both rating agencies cited rising political dysfunction as a primary cause for their downgrades following contentious debt ceiling standoffs. In both cases, the standoffs were resolved, and the federal government did not default."
How will the downgrade impact my finances?
You may see some choppiness in the stock and bond markets, Maier says, but investors are mostly taking this in stride.
The biggest change, he says, is that rates will go up across the board on all sorts of debt to compensate for the added layer of risk.
"The knock-on effects is that there will be higher mortgage and credit card rates," Maier says, which could put a strain on American budgets, many of which are already tightening.
"The consumer is running down cumulative savings left over from the pandemic," he adds. "Credit card balances have increased. And in October, many consumers will have to start repaying their student loans again."
On the flip side, you'll earn a more robust interest rate in exchange for parking your money in a savings account or using it to buy bonds. "That gives people options," Maier says. "You can have a more balanced portfolio between stocks and bonds if you want."
So nothing dire? No default? No recession?
Although a ding in the U.S. credit rating means that Fitch thinks it's likelier than before that the U.S. will default, that continues to be an extremely unlikely scenario, experts say. Even after the downgrade, U.S. Treasurys are likely to maintain their status among the safest investments in the world, says Detrick.
"There might be 11 countries with higher-rated debt than us, but we still like our chances that we have the world's reserve currency and favored debt," he says.
As for a recession, a credit downgrade is likely to have a slowing effect on the economy, but isn't in and of itself enough to tip the economy into recession or push the market into bear territory, Maier says.
Whether the Fed will be able to slow the economy while avoiding a recession remains to be seen, but downgrade or not, much of the economic data remains strong, he says. "GDP numbers came in stronger than expected. And some economists are saying, because the consumer and labor market are strong, that this may be more of a 'soft landing' scenario."
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