Fitch Downgrades U.S. Credit Rating Amid Rising Political Instability and Debt Burden

In a significant economic development, Fitch Ratings has downgraded the U.S. government’s credit rating for the first time by a major ratings firm in over a decade. This decision comes in the wake of escalating political tension over U.S. finances and growing concerns about the national debt burden. The rating now stands at “AA+”, a step down from the previous top “AAA” grade. The downgrade is a reflection of the increasing political dysfunction in Washington and concerns about fiscal management.

This rating downgrade by Fitch can potentially cloud the outlook for the global market for U.S. Treasurys, currently standing at $25 trillion. Despite this, the credit downgrade is unlikely to immediately impact the status of Treasury bonds as a safe-haven security offering nearly risk-free returns. Treasury bonds continue to hold an indispensable role in the global markets and serve as a critical benchmark for returns on stocks and other bonds.

The last time a ratings firm downgraded its headline assessment of the U.S. government’s ability to pay its bills on time was in 2011 when Standard & Poor’s took the step following a contentious debt-ceiling standoff in Congress. The other member of the big three U.S. ratings firms, Moody’s, continues to hold the U.S. at its strongest assessment.

Fitch has attributed this decision to an “erosion of governance” relative to other top-tier economies over the past two decades. The firm cited repeated political standoffs and last-minute resolutions over the debt limit as factors that have undermined confidence in fiscal management.

The Biden administration has criticized Fitch’s decision, arguing that the U.S. was not at risk of defaulting on its debt payments and attributing governance issues to the previous Trump administration. Treasury Secretary Janet Yellen termed the decision as arbitrary and reliant on outdated data. She highlighted that Fitch staff, while justifying their concerns, repeatedly referenced the events of Jan. 6, 2021, when Trump supporters stormed the Capitol, asserting the 2020 election was stolen.

Donald Trump was recently indicted for his attempts to overturn his loss in the 2020 election. He has denied any wrongdoing, accusing prosecutors of politically motivated pursuit.

After months of impasse, Congress passed legislation suspending the government’s borrowing limit in early June, shortly before the deadline set by Yellen. This legislation followed lengthy standoffs between Democrats and Republicans, with the latter demanding spending cuts, which Democrats resisted. During the deadlock, Fitch had indicated a potential downgrade for the U.S.

Fitch expects the general government deficit to increase from 3.7% last year to 6.3% of GDP in 2023. The anticipated deficit growth results from cyclically weaker federal revenues, new spending initiatives, and an increased interest burden. Fitch anticipates the U.S. economy will enter a recession later this year.

Credit ratings are critical for institutional investors and day traders to evaluate the risk of major borrowers, such as governments and corporations, defaulting on their debts. As the U.S. presides over the world’s largest economy and most important currency, it’s typically seen as one of the safest borrowers. However, Fitch’s move may gradually erode global financial markets’ confidence in U.S. creditworthiness, warns Luke Tilley, Chief Economist at Wilmington Trust.

While an abrupt shift in reliance on U.S. Treasurys as a safe-haven benchmark is unlikely, the political instability and the perceived inability to manage fiscal policy effectively are making investors rethink their confidence in the U.S. government’s creditworthiness.

As Tilley points out, “Rome wasn’t built in a day, and it didn’t fall apart in a day either,” signaling that persistent political stalemates might force investors to question the reliability of U.S. fiscal management. This serves as a stark reminder that continued political dysfunction could ultimately undermine the global financial markets’ confidence in U.S. government creditworthiness, with potentially far-reaching economic implications.