The surprise move takes the rating to AA+ from AAA.
In a surprise move August 1, credit rating agency Fitch Ratings downgraded U.S. Treasuries to AA+ from AAA.1 Fitch’s explanation for the downgrade was that it “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.”
A few key points:
The initial move in the Treasury futures market was small, but yields have moved higher due to a combination of factors. The Treasury has announced larger-than-expected auctions of notes and bonds to make up for lack of issuance during the debt ceiling standoff. In addition, the recent move by the Bank of Japan to begin the exit of yield-curve control raises concerns about the country’s appetite for U.S. Treasuries. As a net creditor nation, Japan is a major investor in U.S. Treasuries. With their bond yields rising, there may be less demand for U.S. Treasuries at a time when issuance is rising.
In 2011 when S&P downgraded U.S. debt, yields fell over the subsequent few months because the economy was softening, inflation was declining, and yields were falling in other global markets. The European debt crisis was in the news, lending support to U.S. Treasuries as a safe haven. This time around central banks are hiking rates in most developed markets, creating a more challenging backdrop.
There is no question that U.S. Treasuries are still safe investments. The Fitch decision is highlighting long-term political issues that are preventing the government from coming to an agreement to slow the growth in debt/GDP. Nonetheless, there is still no substitute for U.S. Treasuries in the global economy. The U.S. market is still the largest, most liquid and safest in the world. Investors should not overreact to this announcement. There is no reason to alter a financial plan based on this decision.
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