US downgraded by Fitch due to ‘deterioration of governance’

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And there it is. Fitch, the rating agency, has downgraded the US from its long-held triple A rating to a less prestigious AA+. Consequently, the US now shares a rating level with countries like New Zealand, Austria, and Canada, placing below Denmark and Luxembourg, and coming close to France, Ireland, and Czechia.

This downgrade was largely sparked by the recent impasse surrounding the debt ceiling, which highlights what Fitch refers to as “a gradual deterioration in governance standards over the past two decades” where growing government debt is concerned.

For a detailed explanation, you can read the complete justification here. These are some essential excerpts:

Ratings Downgrade: The downgrade reflects the projected deterioration of the United States’ fiscal situation over the next three years, the mounting and increasing burden of general government debt, and the decline in governance standards compared to peers rated ‘AA’ and ‘AAA’ over the past two decades, evidenced by repeated debt limit standoffs and last-minute resolutions.

Erosion of Governance: Fitch believes that governance standards, particularly in fiscal and debt matters, have steadily declined over the past 20 years, despite the bipartisan agreement to suspend the debt limit until January 2025. The recurrent political standoffs and last-minute resolutions regarding the debt limit have undermined confidence in fiscal management. Additionally, unlike most peer countries, the US lacks a medium-term fiscal framework and has a complex budgeting process. These factors, along with economic shocks, tax cuts, new spending initiatives, and challenges related to rising social security and Medicare costs due to an aging population, have led to successive increases in debt levels over the past decade.

Rising General Government Deficits: We anticipate that the general government (GG) deficit will rise to 6.3% of GDP in 2023, up from 3.7% in 2022. This increase is attributable to weaker federal revenues, new spending initiatives, and a higher interest burden. Moreover, state and local governments are expected to run an overall deficit of 0.6% of GDP this year after having a small surplus of 0.2% of GDP in 2022. The cuts to non-defense discretionary spending agreed upon in the Fiscal Responsibility Act offer only modest improvements to the medium-term fiscal outlook, with projected cumulative savings of USD1.5 trillion (3.9% of GDP) by 2033, according to the Congressional Budget Office. The short-term impact of the Act is estimated at USD70 billion (0.3% of GDP) in 2024 and USD112 billion (0.4% of GDP) in 2025. Fitch does not anticipate any further significant fiscal consolidation measures before the November 2024 elections.

Fitch forecasts a GG deficit of 6.6% of GDP in 2024, expanding further to 6.9% of GDP in 2025. These larger deficits will be driven by sluggish GDP growth in 2024, a higher interest burden, and wider deficits for state and local governments (1.2% of GDP in 2024-2025, in line with the historical 20-year average). Due to the higher debt levels and sustained higher interest rates compared to pre-pandemic levels, the interest-to-revenue ratio is expected to reach 10% by 2025 (compared to 2.8% for the median ‘AA’ rating and 1% for the median ‘AAA’ rating).

This news comes shortly after the US Treasury revised its borrowing estimate for the third quarter to over $1 trillion, and whilst former President Donald Trump announced the impending indictment of another individual. It’s difficult to dispute Fitch’s rationale for the downgrade (even if ratings are not truly consequential).

(P.S. The FT’s automated metadata tool suggested categorizing this under “emerging markets.”)