On Tuesday, Fitch Ratings made headlines by downgrading the U.S. government’s top AAA rating to AA+, becoming the second major credit firm to do so. This move was met with swift condemnation from both the White House and the Treasury Department.
Interestingly, history suggests that this downgrade might actually result in a rally within the Treasury securities market, which is valued at approximately $25 trillion.
Chip Hughey, the managing director of fixed income at Truist Advisory Service, expressed some surprise at the timing of this downgrade, during a phone call on Tuesday evening. However, he pointed out that when comparing this situation to the events of 2011, the immediate response was not focused on the U.S.’s ability to meet its debt obligations. Instead, concerns regarding potential economic growth created a demand for U.S. Treasurys, despite the downgrade.
Back in 2011, S&P Global Ratings downgraded the U.S. credit rating from AAA to AA+ shortly after a debt-ceiling deal was reached in Washington. Fitch had already indicated in May that it might take similar action due to ongoing “brinksmanship” surrounding the debt-ceiling fight. It further warned of this possibility June, following the U.S.’s borrowing limit deal. The actual downgrade occurred roughly a month later.
During the 2011 downgrade, the 10-year Treasury yield dropped from around 3% in August to approximately 1.8% by late September, as reported by FactSet.
Hughey emphasized that we cannot assume that the reaction to this recent downgrade will perfectly mirror that of 2011. On the one hand, there is a potential for a change in perception regarding the creditworthiness of the U.S. However, only time will reveal the true implications of this rating action.
The Concerns Behind the Recent Rating Downgrade
According to Fitch, there are several concerns that led to the downgrade in the US credit rating. These concerns could also create anxieties in the market, causing investors to seek out safe-haven assets.
The rating downgrade is mainly attributed to the expected fiscal deterioration, a high and growing government debt burden, and an erosion of governance. These issues have become more prominent due to repeated debt-limit standoffs and other challenges.
The short-term Treasury bill yields rose above 5% in April and have remained elevated. This is partly due to the Federal Reserve’s efforts to control inflation by raising its policy rate. In fact, the Fed recently increased rates again, bringing them to a 22-year high within a range of 5.25% to 5.5%.
Despite these challenges, investors have been eager to invest in Treasury securities issued since the June debt-ceiling deal. However, the Treasury Department’s $1 trillion borrowing estimate for the third quarter suggests that even more issuance is expected in the future.
Meanwhile, longer-term 10-year Treasury yields, which impact pricing for various loans and real estate debt, stood at 4.048% on Tuesday. This is the second-highest level of 2023, as reported by Dow Jones Market Data.
Interestingly, stocks have defied expectations with a strong rally and are trading at around 5% below record highs. As of Tuesday, the Dow Jones Industrial Average (DJIA) was up 7.5% for the year, while the S&P 500 index (SPX) had increased by 19.2% and the Nasdaq Composite Index (COMP) had surged by 36.5% in 2023, according to FactSet.
It’s worth noting that Moody’s Investors Service still maintains the top Aaa rating for the US with a stable outlook.
Related: Potential Impact of Another Cut to AAA U.S. Credit Rating on the Stock Market Rally
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