The credit rating agency Fitch Ratings announced Tuesday night that it has downgraded the long-term rating of the United States from the maximum grade ‘AAA’ to a lower notch at ‘AA+’. This decision is based on the expectation of fiscal deterioration over the next three years, a growing government debt burden, and the erosion of US governance compared to its highest-rated comparable countries.
Fitch said in its note that over the past two decades there has been a steady decline in governance standards in the country, including issues related to finance and public debt. Despite a bipartisan agreement in June to suspend the debt limit until January 2025, recurring political clashes and last-minute rulings have undermined confidence in Joe Biden’s federal government’s fiscal management.
“The government lacks a medium-term fiscal framework, unlike most of its peers, and has a complex budget process. These factors, along with various economic shocks, as well as tax cuts and new spending initiatives, have contributed successive increases in debt over the last decade,” explains the rating agency in its report on the decision. In this way, Fitch follows the steps that led Standard & Poor’s to make the same decision in 2011. Now only Moody’s maintains the triple A maximum solvency rating for the US.
In addition, the agency highlights that general government deficits are expected to rise, reaching 6.3% of GDP in 2023 due to weaker federal revenues, new spending programs, and higher interest charges. Debt is also expected to rise in the coming years, reaching 118.4% of GDP in 2025, which is more than double the median for ‘AAA’ rated countries.
Medium-term fiscal challenges have also not been addressed, as debt interest costs are expected to double by 2033, with spending on Medicare and Social Security limited significantly due to an aging population, the firm emphasizes. of risk medicine.
Despite the downgrade, Fitch notes that the United States continues to have significant structural strengths that support an AA+ rating that reflects very high creditworthiness. “These include its large, advanced, well-diversified, high-income economy, supported by a dynamic business environment. Fundamentally, the US dollar is the world’s preeminent reserve currency, giving the government extraordinary financial flexibility,” he recalls. .
US entry into recession
In response to the downgrade, the US authorities have stated their commitment to implement measures to address fiscal problems and improve governance. However, analysts and economists warn that concerted efforts will be needed to prevent further fiscal deterioration and maintain investor confidence. The rating outlook remains ‘established’, suggesting that Fitch views the risk of a further downgrade in the near term as limited. However, the authorities must take decisive action to address structural problems and prevent further rating downgrade.
However, the economic outlook also presents challenges, as Fitch projects that the US economy will enter a mild recession in the fourth quarter of 2023 and the first quarter of 2024, with annual GDP growth of just 1.2%. this year and just a modest 0.5% in 2024.
“Tighter credit conditions, weakening business investment and a slowdown in consumption will push the US economy into a mild recession in the quarter. Job vacancies remain higher and the labor participation rate is still lower than before the pandemic, which could negatively affect potential growth in the medium term,” Fitch reports.
Influence of the Fed’s higher rates
The Federal Reserve raised interest rates by 25 basis points in March, May and July 2023. Fitch projected that there will be a further hike from 5.5% to 5.75% by September. However, the resiliency of the economy and the labor market are presenting challenges for the Fed in its goal of driving inflation to 2%.
Although headline inflation fell to 3% in June, core PCE inflation, which is the key price index closely watched by the Fed, remained stubbornly high at 4.1% yoy. This will likely prevent the Fed from cutting interest rates until March 2024.
In addition, the Fed continues to reduce its holdings of mortgage-backed securities and US Treasuries, which is further supporting financial conditions. Since January, these assets on the Fed’s balance sheet have decreased by more than $500 billion as of the end of July 2023.
