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On Wednesday morning, August 2 (Beijing time), Fitch Ratings, one of the three major global rating agencies, downgraded the US long-term foreign currency debt rating from AAA to AA+, and changed the outlook from negative to stable.

This is the first time that the agency has lowered the US rating since it issued its first credit rating for the US in 1994, and also the second time in US history that its credit rating has been downgraded.

Fitch warned that the US debt burden is increasing and its political function is also dysfunctional. After Fitch’s statement was released, the US dollar fell sharply, US stock index futures fell slightly, and US bond futures rose. Even so, some institutions and analysts expect that Fitch’s downgrade of the US rating will have limited impact on the market in the short term.

Jeffrey Young, former global head of foreign exchange at Citigroup and co-founder and CEO of DeepMacro, told NBD that he don't think there will be a large near-term impact although over the long run, it does call attention to unfavorable debt dynamics that could hurt the bond market and the dollar.

After 12 years, the US loses its AAA rating again

According to Fitch’s official website, Fitch Ratings 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'.

Fitch thus became the second major rating agency to strip the US of its AAA rating after Standard & Poor’s.

In a previous debt ceiling crisis in 2011, Standard & Poor's cut the top "AAA" rating by one notch a few days after a debt ceiling deal, citing political polarization and insufficient steps to right the nation's fiscal outlook.

The tumultuous negotiations and gridlock between Republicans and Democrats in June over raising the debt ceiling were evidence that “there has been a steady deterioration in standards of governance over the last 20 years,” Fitch, one of the “big three” U.S. credit-ratings agencies alongside S&P and Moody’s, said in a statement. The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management,” Fitch added.

Fitch expects America's general government deficit to rise to 6.3% of GDP in 2023, from 3.7% in 2022.

Why do rating changes by major rating agencies always attract widespread attention? This is because institutional investors and short-term traders rely on credit ratings to assess the risk of major borrowers such as governments and corporations failing to repay their debts. Places that are given lower ratings usually have to pay higher interest rates to compensate investors for borrowing.

Positive short-term impact on dollar

Wall Street Journal reported that for nearly a century, the US’s reliable reputation for repayment has made US Treasuries an indispensable role in global markets, and has long become a safe haven. In addition, Treasuries are also an important benchmark for measuring returns on stocks and other bonds, as investors typically demand higher returns on any other securities they buy.

Regarding the possible impact of Fitch’s rating adjustment on capital markets, Jeffrey Young, former global head of foreign exchange at Citigroup and co-founder and CEO of DeepMacro, said he does not think Fitch’s rating adjustment will have much impact in the short term.

“In the short run, the primary issue remains that there are few competitors. The US has the world's largest and deepest capital markets, and other large markets (ie, Japan or Italy) are not investable to the same degree. Japan has very weak growth potential and fearful debt dynamics; Italy also has weak growth and it neither has control of its currency, not is it a member of a currency union that has a stable design over time. China does not have fully open capital markets. So it is still a case of "TINA" ("there is no alternative")," Jeffrey Young told NBD.

Zhang Chao, a researcher at Taihe Think Tank, also pointed out in an interview with NBD that since Fitch’s downgrade of the US rating is a follow-up move, it will basically not have a particularly big impact on the market. But Zhang believes that the balance of US Treasury bonds (over $32 trillion) and Q3 new bonds (will reach $1 trillion) will definitely have a greater impact on Treasury yields.

According to information updated on the website of the US Treasury Department recently, as of July 27th, the scale of federal government debt reached $32.659 trillion, an increase of $392.75 billion from last month. The Cato Institute, a US think tank, warned that the continuous increase in federal government debt will lead to the suppression of private investment, the increased risk of sudden fiscal crises, and has become a “national security” issue for the US. It is predicted that by 2030, the scale of US national debt will exceed $50 trillion.

“US rating-downgrade, coupled with the US’s short-term huge bond issuance plan, puts pressure on the yields of US Treasuries of various maturities, while also withdrawing a large amount of liquidity from the market. But in the short-term, it will be positive for the US dollars, which is exactly the opposite of the rating downgrade. When short-term liquidity is withdrawn in large quantities, the momentum for US stocks to continue to rise will be greatly weakened.” Zhang Chao explained to NBD.

However, according to The Washington Post, investors are still continuing to buy Treasuries from the US, and Treasury prices have not soared yet, indicating that investors still believe that the federal government will repay its debts.