US Debt: What Does The Loss Of A Triple A Rating Mean?

The top three global ratings agencies: S&P Global, Fitch and Moody’s, use the same system of letters, ranging from a top AAA rating through B, C and D for payment defaults.

The ratings are intended to reflect the economic and/or financial health of a borrower. For countries, the agencies look at economic growth, tax revenue, government spending, deficits and debt levels to determining their ratings.

These ratings are intended for use by investors to guide them in their investment choices.

The lower a rating, the more investors are likely to demand higher interest payments from a borrower to compensate for the risk of not getting repaid.

Only a small group of nations have a triple-A rating from all three major ratings agencies: Australia, Denmark, Germany, Luxembourg, the Netherlands, Norway, Singapore and Switzerland.

Several others have an AAA from one or two of the agencies. That is the case with the United States, which still has a triple-A from Moody’s. S&P stripped the United States of its AAA in 2011.

Canada and the European Union are in a similar situation.

In Europe, several countries including France lost theirs in the wake of the 2008 global financial crisis.

For France, “it was a leap into the unknown,” the founder of the Global Sovereign Advisory consultancy, said earlier this year of the country’s downgrades in 2012 and 2013.

But the county “didn’t lose investors” then or when Fitch lowered its rating in March when the country was in the midst of a wave of strikes over a contentious pension reform.

Fitch’s downgrade of the United States was the first time it has changed its rating for Washington since it began rating it in 1994.

Moody’s has not changed its rating for the United States since 1949.

The loss of a triple-A rating is above all symbolic: it sends a strong signal to the markets. In this case, the United States is keeping a very strong AA+ rating and the downgrade will unlikely cause investors to flee as the country still enjoys the confidence of markets and its debt is a critical part of the global financial system.

The yield — or interest rate — on US 10-year Treasuries (bonds) which are the reference for the market, rose above 4.0 percent for the third time this year just before Fitch’s announcement, and dipped immediately following it.

They have been approaching that level as the US Federal Reserve raises its interest rates, and the dollar rose slightly against the euro on Wednesday in a sign of the greenback’s role as a safe haven in times of uncertainty.

Global stock markets were lower, but only moderately so.

Fitch itself intimated that there would likely be little immediate consequence from its downgrade for the United States.

In explaining its decision, Fitch noted “the US dollar is the world’s preeminent reserve currency, which gives the government extraordinary financing flexibility.”

Analysts agree that there is unlikely to be a significant impact.

“Despite the poor eye candy and initial surprise, the recent US downgrade will unlikely cause a significant Treasuries sell-off or prompt a major shift in investor behaviour mainly because investors experienced a similar downgrade from S&P in 2011 and came away unscathed,” said Stephen Innes, managing partner at SPI Asset Management.

Analysts at Capital Economics agreed there would be little impact on the US bond markets, and expressed surprise about the timing of the Fitch downgrade “when the economy now appears poised to pull off the seemingly impossible trick of bringing inflation back to target without triggering a recession”.

While it noted the federal deficit is set rise to nearly six percent of GDP and interest costs on government debt set to double in the coming years, Capital Economics said that a lot depends on whether the Fed can soon begin to lower interest rates.

If it can’t “then the debt dynamics could quickly become unsustainable,” it warned.

bur-alb/rl/giv