U.S. Downgrade a Reminder That Rising Deficits Can Have a Cost

The sovereign credit rating cut is unlikely to significantly change views toward U.S. Treasuries, but questions about debt sustainability may grow louder over time.

For the second time in 12 years, one of the three main credit rating agencies has stripped the U.S. government – the world’s largest issuer of sovereign debt – of its top-tier triple-A credit rating. While this week’s move by Fitch Ratings is symbolically significant and carries practical implications for markets as well, we would not expect it to trigger large selling of U.S. Treasuries nor a near-term shift in investor behavior.

Importantly, we do not believe the downgrade reflects new material information concerning the soundness of the U.S. government. U.S. Treasuries continue to be considered the benchmark, risk-free asset class of choice and act as a reference point across financial markets globally. We also do not foresee the downgrade affecting the magnitude or speed of the U.S. Federal Reserve’s rate-hiking cycle in its fight against inflation.

We are currently broadly neutral on U.S. duration – a measure of interest rate risk – and will continue to adjust duration positioning based on our fair-value range.

Rating reduction redux

Fitch on 1 August 2023 cut its sovereign credit rating for the U.S. by one notch, to AA+ from AAA, citing three main factors:

  • Expected fiscal deterioration over the next three years.
  • A high and growing general government debt burden.
  • The erosion of governance relative to similarly rated peers over the last two decades has manifested itself in repeated debt limit standoffs and last-minute resolutions.