Authored by Bill Herrmann

Last July, Fitch Ratings (Fitch), one of the three major credit rating agencies, wasn’t so sure that the U.S. government deserved its AAA credit rating. As a result, the company announced that it was placing the United States on a negative rating watch, the first step towards a potential downgrade.

Fitch’s actions received only slight news coverage relative to the event’s scale, and most market participants took little care either. Given the market environment, perhaps Fitch and others should start sending out their press releases with ‘click bait’ headlines about SPACs or GameStop?

Since July 2020, Fitch’s reasoning for the negative rating watch (NRW) has only been compounded by more-and-more spending (see Exhibit I). Indeed, many could make the argument (including your author) that the U.S. needed to spend plenty of monies to seek to combat COVID-19. However, this is not an opinion piece. The purpose of this outline is to highlight the key parts of Fitch’s NRW — and where the U.S. is now regarding the Fitch concerns — and the Fitch concerns only.

Summary of Key Fitch Rating Drivers (July 2020) (1)

• High fiscal deficits and debt were already on a rising medium-term path even before the onset of the huge economic shock precipitated by the coronavirus and have started to erode the traditional credit strengths of the U.S.
• Growing risk that policymakers will not consolidate public finances sufficiently to stabilize public debt after the pandemic shock has passed
• The U.S. had the highest government debt of any ‘AAA’-rated sovereign heading into the crisis, and general government debt is expected to exceed 130% of GDP by 2021 (see Exhibit II)
• Debt/GDP could stabilize temporarily from 2023 if fiscal balances return to pre-pandemic levels, but only assuming that interest rates stay very low
• It is uncertain whether very low market rates will persist once growth and inflation pick up…At current levels of indebtedness, a 1% rise in the effective rate on the debt would add ~1.2% of GDP to the interest bill in a single year
• There is a potential risk of fiscal dominance if debt/GDP spirals, posing risks to U.S. economic dynamism and reserve currency status

In my view, if the above, in whole or in part, was cause for concern last July (for the few that did know of the NRW), it should now be deeply concerning. For example, Fitch assumed last July that rates would remain very low. From a historical perspective, rates are still relatively low, but they have risen with extreme volatility throughout the last several months.

Summary of Recent Fitch Statement (March 2021) (2)

To the fanfare of basically nobody at all (again), Fitch, only a few weeks ago, responded to its analysis for placing the U.S on NRW. Below are the main takeaways.

• The $1.9 trillion American Rescue Plan (ARP) points to a delayed return to a fiscal stance consistent with stabilization of the government debt ratio…Because of the APR, U.S debt stabilization “is further away than when Fitch placed the U.S. Sovereign Rating of ‘AAA’ on Negative Outlook in July 2020” (3) (emphasis added)
• Without a fiscal anchor and in light of the ambitions of the administration, fiscal policy may be more expansionary, leading debt to rise more rapidly
• Low-interest rates, which have held down debt service costs, will eventually rise despite the Federal Reserve’s commitment to an extended period of highly accommodative monetary policy

Fitch Doubles-Down:
“At the time of the review of the U.S. rating in July 2020, we said that we would assess what steps the new administration took toward deficit consolidation in the post-pandemic phase”, noting that “the rating could be downgraded in the absence of a credible commitment to address medium-term public spending and debt challenges.” (4) (emphasis added)

Recall that in August 2011, Standard & Poor’s (S&P), another of the three major rating agencies, downgraded U.S. debt (5). The S&P downgrade from 2011 caused sudden and heighten volatility that brought the three major U.S equity averages down 7–8% (in one day, post downgrade). If one is under the assumption that this time is different, they would be mistaken. A downgrade of U.S debt has happened before, and it will happen again — it’s simply a question of when, not if.

Exhibit I

Exhibit II

1. “Fitch Revises United States’ Outlook to Negative; Affirms at ‘AAA’.” Fitch Ratings. July 31, 2020

2. “U.S. Stimulus Will Boost Growth at a Cost of Higher Deficits, Debt.” Fitch Ratings. March 8, 2021

3. Supra at note 2.

4. Supra at note 2.

5. “United States of America Long-Term Rating Lowered to ‘AA+’ Due to Political Risks, Rising Debt Burden; Outlook Negative.” Standard & Poor’s. August 5, 2011.

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