Fitch Ratings has downgraded the US' long-term foreign-currency issuer default rating (IDR) to 'AA+' from 'AAA'. It also removed the rating watch negative and assigned a stable outlook to the country while affirming the country ceiling at 'AAA'. According to Fitch projections, tighter credit conditions, weakening business investment, and a slowdown in consumption will push the US economy into a mild recession in the fourth quarter (Q4) of 2023 and the first quarter (Q1) of 2024.
"The rating downgrade of the US reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to 'AA' and 'AAA’-rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions," the rating agency says.
According to Fitch, there has been a steady deterioration in governance standards in the US over the past 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025. "The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management. In addition, the government lacks a medium-term fiscal framework, unlike most peers, and has a complex budgeting process. These factors, along with several economic shocks as well as tax cuts and new spending initiatives, have contributed to successive debt increases over the last decade. Additionally, there has been only limited progress in tackling medium-term challenges related to rising social security and medicare costs due to an ageing population."
"We expect the general government (GG) deficit to rise to 6.3% of gross domestic product (GDP) in 2023, from 3.7% in 2022, reflecting cyclically weaker federal revenues, new spending initiatives and a higher interest burden. Additionally, state and local governments are expected to run an overall deficit of 0.6% of GDP this year after running a small surplus of 0.2% of GDP in 2022. Cuts to non-defence discretionary spending (15% of total federal spending) as agreed in the fiscal responsibility act offer only a modest improvement to the medium-term fiscal outlook, with cumulative savings of US$1.5trn (trillion) (3.9% of GDP) by 2033 according to the congressional budget office (CBO). The near-term impact of the Act is estimated at US$70 billion (0.3% of GDP) in 2024 and US$112 billion (0.4% of GDP) in 2025," it added.
Fitch says it expects no substantive fiscal consolidation measures ahead of the November 2024 elections.
According to the rating agency, over the next decade, higher interest rates and the rising debt stock will increase the interest service burden, while an ageing population and rising healthcare costs will raise spending on the elderly absent fiscal policy reforms in the US.
The CBO projects that interest costs will double by 2033 to 3.6% of GDP. The CBO also estimates a rise in mandatory spending on medicare and social security by 1.5% of GDP over the same period. The CBO projects that the social security fund will be depleted by 2033 and the hospital insurance trust fund, used to pay for benefits under medicare part A, will be depleted by 2035 under current laws, posing additional challenges for the fiscal trajectory unless timely corrective measures are implemented.
Additionally, the 2017 tax cuts are set to expire in 2025, but there is likely to be political pressure to make these permanent as has been the case in the past, resulting in higher deficit projections, the rating agency added.
The US Fed raised interest rates by 25bps (basis points) in March, May and July 2023. Fitch says it expects one further hike to 5.5% to 5.75% by September. "The resilience of the economy and the labour market are complicating the Fed's goal of bringing inflation towards its 2% target. While headline inflation fell to 3% in June, core PCE (personal consumption price) inflation, the Fed's key price index, remained stubbornly high at 4.1% year-on-year (y-o-y). This will likely preclude cuts in the Federal Funds Rate until March 2024. Additionally, the Fed is continuing to reduce its holdings of mortgage-backed securities and US treasuries, which is further tightening financial conditions. Since January, these assets on the Fed balance sheet have fallen by over US$500 billion as of end-July 2023."