Fitch Downgrades the US Credit Rating from AAA to AA+

The credit rating agency cited a variety of factors in its decision yesterday afternoon, but the highlight is here:

In Fitch's view, there has been a steady deterioration in standards of governance over the last 20 years…The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management.

I was immediately reminded of the Standard and Poor’s debt downgrade we went through in 2011. That day, the stock market dropped over 5%, and it took nearly 6 months for prices to recover.

Here are some of our initial Thoughts & anticipated questions from yesterday’s news:

1. Will investors dump US Debt? Only if they absolutely require AAA ratings on their bond holdings, which seems unlikely. AA+ is still marked “High Quality”.

2. Are interest rates/borrowing costs are going up? Probably. In general, less stable borrowers pay a higher interest rate.

3. What happens to treasury yields? They probably rise, see #2.

4. What happens to the dollar? It probably weakens. However, the dollar has appreciated vs most other currencies over the past 5 years, so a reversion wouldn’t be too surprising.

5. When will we be upgraded back to AAA? This is hard to say, S&P have maintained our AA+ status ever since their downgrade in 2011.

6. Who will be impacted? As we saw over the past few years, interest rates impact valuations across the board- they have a ripple effect on everyone. The most direct impact is on fixed income holders and borrowers though.

7. What’s similar to 2011? Our economy was still fragile following a financial crisis, and we were headed into a re-election in 2012.

8. What’s different from 2011? The Fed Funds (FF) rate was effectively 0% in 2011, so an interest rate shock rattled markets. Today, the FF Rate is over 5%, so an interest rate change is (proportionally) less impactful.

Final thoughts: Fitch’s US downgrade shouldn’t be a huge surprise, given the debt ceiling theater of recent years.

This is not our first downgrade rodeo. Additionally, our economy is on much better footing today than it was in 2011. Unemployment was nearly 9% then. Today, it’s less than 4%. Our economy seems better prepared to handle “a shock to the system” this time.

All things considered, the US Dollar and economy are still (in our view) “the cleanest of the dirty shirts”; From an investment perspective, America is preferable to most other economies worldwide.