US Treasury debt, the global benchmark for nominally “risk-free” securities, was downgraded for the second time in history late Tuesday. Fitch Ratings lowered the credit grade of US government bonds from AAA to AA+, citing a rapidly worsening fiscal outlook and an increasing vulnerability to economic shocks.
On August 5, 2011, S&P Global also downgraded the US sovereign debt rating from AAA to AA+. The downgrades indicate that doubt is growing regarding the US government’s capability to meet its financial obligations.
While the United States has been getting deeper in debt each year, the outlook for the nation’s fiscal health has been progressively deteriorating along a broader front. In particular, Fitch Ratings cited “repeated debt-limit political standoffs and last-minute resolutions [which] have eroded confidence in fiscal management,” referring to the increasing frequency of brinkmanship in budget and debt ceiling negotiations over the past decade or two. Further, the agency stated that “the [US] government lacks a medium-term fiscal framework, unlike most [or its] peers, and has a complex budgeting process.” A broad array of new government spending programs have been undertaken and added to, year after year, with little to no progress in arresting fiscal profligacy.
US Treasury Public Debt Outstanding (WWII – present)
(Source: Bloomberg Finance, LP)
Fitch expects the government deficit to nearly double from 3.7 percent in 2022 to 6.3 percent in 2023. The US Federal deficit reached $1.39 trillion for the first nine months of the current fiscal year, 170% higher than this same point during the last fiscal year.
Additionally, the US Treasury boosted its borrowing projections for the current quarter from $733 billion to over $1 trillion. Despite that, US Treasury Secretary Janet Yellen responded shortly after the downgrade notice, calling the decision by Fitch “outdated.”
Her characterization is categorically accurate: the median debt-to-GDP ratio of AAA rated sovereign debt issuers is currently 39.3 percent; for AA rated issuers, 44.7 percent. The current US debt-to-GDP ratio is 112.9 percent. Even before the COVID pandemic, in 2019 the ratio stood at 100.1 percent. The last time America’s debt-to-GDP ratio was at the current AAA median level was between 1978 and 1979.
US debt-to-GDP ratio (1970 – present)
US Office of Management and Budget (blue), International Monetary Fund (red)
(Source: Bloomberg Finance, LP)
The initial reaction in US Treasury markets early Wednesday was a slight increase in yields for US government obligations with maturities of five years or longer. The US Dollar Index was essentially unchanged. Large financial asset managers will now face the dilemma of whether to move their US Treasury bond holdings into a category associated with marginally riskier securities, or to disregard the guidance of the rating agencies.
The reduction of the US credit rating is overdue in light of the long and enthusiastic abandonment of fiscal soundness in Washington DC, recently abetted by monetary policy authorities. A nation simultaneously so dependent upon outside financing while so eager to throw its weight around globally would be wise to, at the very least, keep its books somewhat orderly. US citizens would be well advised to consider both the recent bulking up of the Internal Revenue Service and rapid innovation of central bank digital currencies (CBDCs) in weighing the likelihood of sudden fiscal reform versus the exploration of new means of enhancing revenue.