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Fitch surprises with a downgrade of the US rating to AA+: first reactions from Asset managers
Macro

Fitch surprises with a downgrade of the US rating to AA+: first reactions from Asset managers

Fitch has also taken into account the “erosion of governance” in the US compared to other ‘AA’ and ‘AAA-rated countries.
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3 AUG, 2023

By RankiaPro Europe

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Fitch Ratings has delivered surprising and discouraging news for the United States. The credit rating agency has decided to downgrade the country's long-term debt rating by one notch, from triple-A ('AAA') to 'AA+', with a stable outlook. This downgrade reflects the expectation of a fiscal deterioration over the next three years and the growing weight of government debt.

In addition to the fiscal aspect, Fitch has also taken into account the "erosion of governance" in the US compared to other 'AA' and 'AAA-rated countries over the past two decades. Here are the reactions of international fund managers to the downgrade.

James Athey, Chief Investment Officer, abrdn

Although there has been some resistance from within the administration, the reality is that the downgrade of the US rating seems fully justified. The debt-to-GDP ratio is now over 100%, compared to the average for AAA-rated countries, which is around 40. Moreover, this ratio is expected to increase significantly in the coming years. Interest costs have risen significantly, both in absolute terms and as a percentage of the overall budget, and even at the end of what has become a major cyclical upswing, the US is still running a budget deficit of over 6%. It has also become clear in recent years that neither Democrats nor Republicans are willing to put fiscal policy on a more sustainable path.

The impact of the downgrade on the price of US Treasury yields should have relatively little effect. This is because relatively few assets are benchmarked to AAA bonds, especially in recent years when the universe has shrunk. The biggest impact on yields is being felt by the increased supply of US Treasuries resulting from the huge pro-cyclical deficit. Combined with the ongoing disinflationary process, strong economic data but increasing monetary headwinds, we expect longer-term USTs to continue to underperform the yield curve.

Mike Riddell, Head of Macro Unconstrained team at Allianz GI

In my opinion, the importance and relevance of rating agencies is often overstated. Unless it is a case of moving to junk when you can see a lot of forced sellers. It's natural that people look at the summer of 2011 when S&P downgraded the US rating from AAA- - around this time we saw a huge US Treasury rally coupled with a major risk asset selloff. But this is probably mixing up causality with correlation, where US economic data was exceptionally weak.

Similarly, recent US Treasury market moves are likely driven by data that has been a bit stronger than expected, coupled with a big jump in US Treasury issuance expectations, which is putting pressure on longer-dated US Treasuries. It's probably not much to do with Fitch at all.

Lisa Hornby, head of US multi-sector fixed income at Schroders

We expect the impact of Fitch's downgrade of the US rating to be limited, as following S&P's downgrade in 2011, most investors rewrote their investment management accounts (IMAs) to accommodate US Treasuries, regardless of their rating. That said, we believe that, over the medium term, it will cause investors to rethink the US debt burden and its sustainability at these levels. It is very unusual to have a budget deficit of 8.5% in a non-recessionary period and we suspect that over time this will increase the term premium demanded on US Treasuries and put downward pressure on the dollar. In terms of market sentiment, we expect this Fitch downgrade to be much better digested by risk markets than the S&P downgrade 12 years ago, which coincided with a European sovereign debt crisis, was the first downgrade from AAA, and was associated with a potential default as opposed to longer-term fundamental trends.

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