Fitch Flips the Switch

Friday, August 4, 2023

Fitch downgraded the U.S. long-term rating to AA+ from AAA

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 that has manifested in repeated debt limit standoffs and last-minute resolutions.

Our Takeaway

• The downgrade from Fitch is largely noise and provides less signal for further developments. If the markets are destined to retreat from current prices, it is highly unlikely to be triggered solely by Fitch's downgrade.
• While debt rating agencies play an important role in the sale of debt into capital markets, their influence on forward-looking outcomes for markets is minimal, if any. In fact, their track record in being forward-looking has been spotty at best.
• The vast majority of funds, such as money market or other structural holders of treasuries, consider treasuries themselves as "risk-free" assets, rather than relying on the rating from an agency. This significantly reduces concerns about knock-on effects from forced sellers needing to exit treasuries.
• Treasuries continue to be the preferred risk-off asset, especially with higher yields today compared to 2021. A similar scenario occurred in 2011, coincidentally in August, when S&P downgraded the U.S. for comparable issues. The market dropped 6% over the following days, while treasuries rallied. From August 6, 2011, to year-end, the S&P 500 was flat (-0.004%), and one year forward from August 6, it returned 14.25%.

While Fitch's individual downgrade may not hold significant weight, it does illuminate a broader concern. Elevated levels of U.S. debt, poor fiscal management, and brinksmanship (i.e., debt ceiling) can ultimately have an impact. These are long-term macro factors that we consider and discuss to assess their potential impact on portfolio construction. We applaud the agency’s decision to chart a more proactive stance, rather than the industry’s well documented history of troubling reactive tendencies. Unfortunately, much of their credibility was lost following their dismal showing during the global financial crisis.

As always, please reach out with any questions and we will do our best to address them.