It has been a while since a ratings agency has grabbed the headlines. That is partly due to their failures with “AAA” Mortgage Backed Securities pre credit crunch and their reputation during the Euro area crisis for closing the stable door after the horse had bolted. But this did achieve some impact last night.
Fitch Ratings – London – 01 Aug 2023: FitchRatings has downgraded the United States of America’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘AA+’ from ‘AAA’. The Rating Watch Negative was removed and a Stable Outlook assigned. The Country Ceiling has been affirmed at ‘AAA’.
So the world’s reserve currency is no longer AAA according to it and there did seem to be a market impact as the US ten-year yield rose above 4%. Although it was there in early July as well. It provokes an initial thought but let’s continue with the Fitch analysis.
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.
Actually the whole debt limit system has become something of a farce. We can now look at their numbers including my initial though which I have highlighted.
Rising General Government Deficits: We expect the general government (GG) deficit to rise to 6.3% of GDP in 2023, from 3.7% in 2022, reflecting cyclically weaker federal revenues, new spending initiatives and a higher interest burden
They think that will get worse over the next couple of years.
Fitch forecasts a GG deficit of 6.6% of GDP in 2024 and a further widening to 6.9% of GDP in 2025. The larger deficits will be driven by weak 2024 GDP growth, a higher interest burden and wider state and local government deficits of 1.2% of GDP in 2024-2025 (in line with the historical 20-year average).
National Debt
This has been rising even allowing for the pandemic.
General Government Debt to Rise: Lower deficits and high nominal GDP growth reduced the debt-to-GDP ratio over the last two years from the pandemic high of 122.3% in 2020; however, at 112.9% this year it is still well above the pre-pandemic 2019 level of 100.1%. The GG debt-to-GDP ratio is projected to rise over the forecast period, reaching 118.4% by 2025.
I always have a wry smile at numbers of around 120% for this area as it is the threshold the Euro area used to show when the numbers were out of control. This then rather backfired as Portugal and Ireland joined Greece in exceeding it.
Debt Costs
These are an increasing issue which Fitch puts like this.
The interest-to-revenue ratio is expected to reach 10% by 2025 (compared to 2.8% for the ‘AA’ median and 1% for the ‘AAA’ median) due to the higher debt level as well as sustained higher interest rates compared with pre-pandemic levels.
Plus this.
The CBO projects that interest costs will double by 2033 to 3.6% of GDP.
Now the Congressional Budget Office is the US version of the OBR and are therefore unlikely to be even remotely accurate. But even they have been unable to miss the present direction of travel. There has been a clear change since the US Federal Reserve was actively suppressing debt costs via interest-rate cuts and large-scale asset purchases. Whereas now it is doing this.
Fed Tightening: The Fed raised interest rates by 25bp in March, May and July 2023. Fitch expects one further hike to 5.5% to 5.75% by September………Additionally, the Fed is continuing to reduce its holdings of mortgage backed-securities and U.S. Treasuries, which is further tightening financial conditions. Since January, these assets on the Fed balance sheet have fallen by over USD500 billion as of end-July 2023.
As I have pointed out many times this is am awkward shift for central bankers who were flavour of the month in political circles and now will be under fire. But there is more to it than just interest-rate rises.
Post-pandemic, TIPS share declined to 7.5%, but a steady increase of $10 to $20bn per year starting in 2022
could return the TIPS share towards 8% by the end of 2024 and would be in line with a regular and predictable
issuance pattern. ( US Treasury)
Actually the US Treasury goes onto inadvertently make my point with this which feels like from another world now.
Based on debt payments to date, the TIPS program has saved Treasury an estimated $17bn relative to nominal
issuance, indicating that Treasury has captured inflation risk premium over time.
But the principle here is that there has been another rise in debt costs due to inflation. Ironically that has been reduced because the Federal Reserve bought some but the message is a return towards pre credit crunch levels for debt interest.
US debt-service costs are the highest since 2009: ( @unusual_whales )
That will continue to rise because as we have seen the US continues to borrow ( 6-7% of GDP) and bonds will mature. So things get worse even if yields stay here. Inflation will still be an issue although much less so than last year.Last month Bloomberg pointed out this.
The cost of servicing US government debt jumped by 25% in the first nine months of the fiscal year, reaching $652 billion and contributing to a major widening in the budget deficit.
There are various reports of it heading for US $1 trillion based on higher bond yields and we do look to be heading that way. Although things can change.
Economic Growth
In the end this is the most important factor usually.
Economy to Slip into Recession: Tighter credit conditions, weakening business investment, and a slowdown in consumption will push the U.S. economy into a mild recession in 4Q 23 and 1Q 24, according to Fitch projections. The agency sees U.S. annual real GDP growth slowing to 1.2% this year from 2.1% in 2022 and overall growth of just 0.5% in 2024.
So many of the numbers used by Fitch for the deficit and national debt get better with economic growth and worse without it. Putting it another way in my time here I have seen many UK government forecasts based on 3% GDP growth per annum. That is because nearly everything is affordable if your economy compounds at 3% per annum. Putting it another way that is why the Euro area and IMF forecast 2%+ for Greece. The problem with all of that has been a reality which has been different and in Greece’s case very different.
The US has in general done better than others in GDP growth terms. But I too am worried about a slowing as I fear a delayed reaction to the interest-rate increases with so much debt being fixed-rate and the problems that China clearly has.
Comment
We can look at this via the official response.
US Tsy Sec. Yellen: Strongly Disagree With Fitch Ratings’ Decision To Downgrade US – Calls Downgrade ‘Arbitrary And Outdated’ ( @LiveSquawk)
Unfortunately she has an even worse record than the ratings agencies after her assurances that inflation would be Transitory.
In the end as I explained earlier the path essentially depends on economic growth. With the long-term trend for that Fitch do have a point although their issuing a statement may be a sign of change the other way. Their lagged response to events often means that they represent a turning point.
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