Fitch downgrades US credit rating to AA+: All you need to know

The US suffers a decline in credit rating from AAA to AA+.

Fitch Ratings has downgraded the US’ sovereign credit grade by one level from AAA to AA+ on the basis of 'ballooning fiscal deficits and erosion of governance' that have caused repeated debt limit emergencies over the past two decades, Bloomberg reported on August 2.

The Fitch downgrade echoes a similar move made by Standard & Poor’s Global Ratings in 2011 due to the government’s borrowing limit, as per an Associated Press report. The standoff then had raised the US Treasury borrowing costs by $1.3 billion that year, as per a 2012 report by the Government Accountability Office.

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Over time, a lower credit rating could raise borrowing costs for the US and here's all you need to know about the situation.

Fitch’s statement of reasons

While the move seems to have caught US officials by surprise, all three major agencies had warned the country its AAA credit grade is at risk, as per an AP report. Earlier in May, Fitch had put the US credit on ‘Rating Watch Negative’ – an implicit warning that a downgrade may come.

“Tax cuts and new spending initiatives coupled with multiple economic shocks have swelled budget deficits, while medium-term challenges related to rising entitlement costs remain largely unaddressed. The rating downgrade of the United States reflects 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,” Fitch said in a statement.

Fitch's report cited "a steady deterioration in standards of governance over the last 20 years" and said "repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management."

The statement further forecasts the country’s rapidly swelling debt burden to reach 118 percent of gross domestic product (GDP) by 2025, over 2.5x higher than the ‘AAA’ median of 39.3 percent. It also noted that the debt-to-GDP ratio will rise in the longer term making the US 'increasingly vulnerable to future economic shocks'.

Officials’ react with surprise

US Treasury Secretary Janet Yellen called the downgrade 'arbitrary and outdated' adding that “Fitch’s decision does not change what Americans, investors, and people all around the world already know: that Treasury securities remain the world’s preeminent safe and liquid asset, and that the American economy is fundamentally strong.”

Besides Yellen, other economy watchers also expressed surprise over the move. Mohamed El-Erian, chief economic adviser at Allianz SE and a Bloomberg Opinion columnist expressed puzzlement over the timing and many aspects of the announcement.

Former Treasury Secretary Larry Summers also criticised Fitch. “The United States faces serious long-run fiscal challenges, but the decision of a credit rating agency today, as the economy looks stronger than expected, to downgrade the United States is bizarre and inept.”

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“This is a bizarre and baseless decision for Fitch to make now. US governance, by Fitch's measures, had improved during the Biden presidency. It simply defies common sense to take this downgrade as a result of what was really a mess caused by the last administration and reckless actions by congressional Republicans," a senior Biden administration told Reuters.

The official added that it would be surprising to see a significant increase in federal borrowing costs as a result of the downgrade, based on the limited market reaction so far, and a decline in rates after the 2011 downgrade.

Announcement causes ripples

Yields on two-year Treasuries fell three basis points to 4.87 percent after the ratings downgrade, while those on 10-year US bonds slipped one basis points to 4.01 percent, Bloomberg reported.

The yield on 30-year US debt rose to the highest in almost nine months on August 1 as the Treasury Department prepared to ramp up issuance of longer-dated securities to fund its widening budget deficit.

On July 31, the Treasury increased its net borrowing estimate for the July-through-September quarter to $1 trillion, more than some analysts expected and well above the $733 billion it had predicted in early May. The Treasury will preview its quarterly financing plans on Wednesday at 8:30 a.m. in Washington.

On the political front, Democrats have called out Republicans for dragging decisions on the US debt ceiling in May this year. While Republicans are citing ‘Bidenomics’ for the downgrade.

The Democrats on the Ways and Means Committee, in a statement called the default crisis a “manufactured by the Republicans”. Biden's re-election campaign spokesman Kevin Munoz and White House Press Secretary Karine Jean-Pierre also blamed Trump and congressional Republicans for the downgrade; while House GOP campaign spokesman Jack Pandol blamed ‘Bidenomics’.

Uncertainty injected in markets

US stock futures fell after the Fitch downgrade. Dow Jones Industrial Average futures slid by 75 points, or 0.2 percent. S&P 500 and Nasdaq-100 futures dipped 0.3 percent and 0.4 percent, respectively.

Advanced Micro Devices rose 2 percent in extended trading after reporting better-than-expected quarterly results. The broad market index fell 0.27 percent, while the Nasdaq Composite declined 0.43 percent. Meanwhile, the Dow Jones Industrial Average added 71.15 points, or 0.2 percent. At one point during the session, the Dow reached its highest level since February 2022.

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"Most of the Asia turmoil this morning and the Treasury yields move is triggered by the Fitch decision. It's kind of a short-term knee-jerk reaction, so we will have to wait and watch for how this pans out," said Manishi Raychaudhuri, head of Asia Pacific equity research at BNP Paribas told Reuters.

Asian stocks also traded lower. The MSCI's broadest index of Asia-Pacific shares fell 0.5 percent. Japan's Nikkei slid by 1.2 percent, while Australian shares edged down 0.5 percent. China's mainland benchmark and Hong Kong's fell by 0.3 percent and 0.5 percent, respectively.

"This basically tells you is the US government's spending is a problem. It's an unsustainable budget situation because the economy can't even grow its way out of this problem going forward. Therefore, they're going to have to either tackle it or accept the consequences of potential further additional downgrades," said Steven Ricchiuto, US chief economist, Mizuho Securities told Reuters.

(With inputs from Bloomberg, Reuters and other agencies)