[ANALYSIS] US downgraded at Fitch Ratings; decision to have little market impact, analysts say

US DOWNGRADED AT FITCH: Fitch downgraded US long-term ratings to 'AA+' from 'AAA', with a stable outlook. Fitch cited increasing debt, weak governance, and anticipated fiscal decline over 3 years, leading to debt standoffs.

MOTIVATIONS FOR THE DOWNGRADE: It said that "there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025," adding that "the repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management," and that "the government lacks a medium-term fiscal framework, unlike most peers, and has a complex budgeting process." These factors, along with several economic shocks as well as tax cuts and new spending initiatives, have contributed to successive debt increases over the last decade. Additionally, there has been only limited progress in tackling medium-term challenges related to rising social security and Medicare costs due to an aging population.

FITCH'S OUTLOOK FOR THE US: Fitch predicts a mild recession in late 2023/early 2024 due to credit tightening, lower business spending, slower consumption. Fitch sees US GDP growth decreasing to a rate of 1.2% this year from 2.1% in 2022, and sees only 0.5% growth in 2024. The rating agency said that job vacancies were high, but labour participation remains below pre-pandemic levels, impacting potential growth.

FITCH ON THE FED: It noted that the Fed increased interest rates three times this year, and may do so again to 5.5-5.75% by September. But still, the strong economy and high inflation make reaching the 2% target tricky, and inflation remains high, delaying the prospect of rate cuts until 2024.

TREASURY RESPONSE: Treasury Secretary Yellen described the downgrade as "arbitrary", claiming that it was based on "outdated data" from 2018-2020. Yellen strongly disagreed with Fitch's decision, adding that the US Treasury securities remain the world's preeminent safe and liquid asset, and the US economy was fundamentally strong.

STREET'S TAKE: Goldman Sachs said the downgrade mainly reflects governance and medium-term fiscal challenges, but does not reflect new fiscal information, adding that the move should have little direct impact on financial markets as it is unlikely there are major holders of Treasury securities who would be forced to sell based on the ratings change. Former Treasury Secretary Summers, a Democrat, said Fitch's decision was "bizarre and inept," and the US economy was stronger than expected. Allianz' chief economic adviser Mohamed El-Erian said Fitch's decision was "strange", and was more likely to be dismissed than have a lasting disruptive impact on the US economy and markets. Capital Economics said that the announcement was not a complete surprise given that Fitch hinted at such a move during the recent debt ceiling standoff, and had a long-standing negative outlook on its AAA rating, adding that it echoes the decision by S&P to cut its own US rating from AAA to AA+ in the aftermath of the 2011 debt ceiling standoff; Moody’s still has the US at AAA, but has maintained a negative outlook.

02 Aug 2023 - 07:26- Fixed IncomeEconomic Commentary- Source: Newsquawk