What Does the Fitch Downgrade Mean for the U.S. Credit Rating? | ETF Trends

By Dr. David Esch

Do Downgraded Treasurys Still Belong in Your Portfolio? What Does the Treasury Downgrade Mean for Your Portfolio?

The creditworthiness of the US Treasury is hugely important – the function of the global economy is built on it. So at first the decision of Fitch, one of three major ratings agencies, to downgrade US debt would seem to matter. But this is old news. Fitch merely downgraded the US debt to the same level that S&P already did in 2011. The stock market’s negative, but small, reaction to the downgrade is an indication that this will not affect the economy or the investor.

On Tuesday August 1, the Fitch Credit rating agency downgraded the US Credit score from the top AAA grade to AA+. The agency cited increasing political dysfunction and growing total debt. This is the first change in rating among the big three credit rating agencies in the US since Standard & Poor’s made a similar change in August 2011. Moody’s still is maintaining the top score.

However, the stability, dominance, and sheer size of the US treasury market should not be underestimated. It underpins the entire global economy as well as the functioning of equity markets and other asset classes. US Treasurys have been and will continue to be the global risk-free asset of choice. Two companies – Microsoft and Johnson & Johnson, as well as several countries are now rated as more credit worthy than the US Treasury. We list the countries below, along with their GDP and the yield of a 10-year sovereign bond. This gives further evidence that US Treasurys will remain highly valued. While it is clear that the US Debt to GDP ratio is edging to relatively high values, the combination of size, growth rate, and competitive yield make the US the most attractive choice, considering just the numbers.


Table: Representative list of countries with best agency credit ratings, and some statistics related to treasury/sovereign debt bonds.
Sources: Bloomberg,  IMF, Report for Selected Countries and Subjects (imf.org). As of August 2, 2023.

Normally, significant events in the US treasury markets cause seismic waves through global equity markets. Although the credit changes caused some reactions in markets, most of these fluctuations were within normal daily volatility. The CBOE VIX was up two points but ended at a relatively ordinary 16.09, still far below levels seen rather recently. Of all the major stock exchanges, NASDAQ fell the most, but like the other exchanges, a good portion of the day’s decline can be attributed to incoming earnings reports not meeting expectations, as well as other ongoing issues in the silicon industry. The S&P rating changes of twelve years ago caused far greater reaction in markets.

Nevertheless, as interest rates rise, the US must pay more to borrow, and the debt will grow with less available control in the hands of the Fed. The ability to change government spending without politically unpopular measures such as entitlement cuts will become even more limited. This is a developing issue that we will all be watching, but today’s change alone should not be reason to panic or change the course of investments.

To sum up, Treasurys of various maturities will continue to be the primary asset for storing value, meeting long-term liabilities, managing risk, and hedging volatility. They are an important component of a portfolio optimized for investors’ goals.

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Disclosures:
New Frontier Advisors LLC (“New Frontier”) is a federally registered investment adviser based in Boston, MA. The information discussed here is for information purposes only. Past performance does not guarantee future results. As market conditions fluctuate, the investment return and principal value of any investment will change. Diversification may not protect against market risk. There are risks involved with investing, including possible loss of principal. Before investing in any investment portfolio, the investor and Financial Advisor should carefully consider the investor’s investment objectives, time horizon, risk tolerance, and fees.