On August 1, 2023, Fitch rating agency downgraded the debt of the U.S. Government from AAA to AA+, citing “the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.” Now that two of the three ratings agencies have rated U.S. debt securities AA+, the ratings of U.S. Treasury debt will drop from AAA to AA+ for both the Bloomberg and ICE bond indices.
Fitch joins S&P, which downgraded the debt of the U.S. Government back in August of 2011, in rating the U.S. at AA+, while Moody’s has maintained its AAA rating, with a stable outlook. The initial reaction to interest rates has been relatively muted, with yields modestly higher and a somewhat steeper yield curve. Longer-term, the downgrade could result in the government paying higher interest rates on their debt at a time when their issuance is increasing. This would be a different outcome from what occurred when S&P downgraded its U.S. debt rating back in 2011, as U.S. Treasury yields actually declined following the announcement. However, the economic environment was very different at that time. Inflation was not a problem, we were entering the European banking crisis, and the Federal Reserve would soon make the announcement that they would keep interest rates near zero for at least the next few years.
Lowering the credit rating of U.S. debt not only impacts Treasury debt, but it can impact interest rates on mortgage debt, corporate debt, and even impact the stock market if investors view the move as a reason to reduce risk. Similar to the 2011 experience with S&P, we expect government agency debt to be downgraded to align with the new U.S. Treasury rating at Fitch.
Our belief is that the downgrade will likely not have a meaningful impact on interest rates as investors will continue to focus their attention on Fed policy and inflation and how that will ultimately impact the outlook for economic growth.
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.
Executive Vice President, Chief Investment Officer, Fixed Income
Boyd Watterson Asset Management. LLC