Market In a Snap! August 4th, 2023

By: Dave Chenet, CFA, CAIA

 CloseWeekly returnYTD return
    
S&P 5004,478-2.27%16.63%
Nasdaq Composite13,909-2.85%32.89%
Russell 2,0001,957-1.14%11.38%
Crude Oil82.632.70%2.88%
US Treasury 10yr Yield3.79%  

Source: YCharts, Yahoo! Finance, WSJ

Does the US Treasury Debt Downgrade Really Matter?

On August 1st, Fitch Ratings, one of the three private credit rating firms, downgraded its U.S. credit rating from AAA to AA+.  In doing so, it joined Standard & Poor’s, which downgraded its U.S. credit rating to AA+ in August of 2011.  Moody’s remains alone in maintaining its AAA rating. Fitch described the drivers of its decision as: rising debt-to-gdp, higher interest rates increasing the cost to service the debt as bonds rollover, rising medicare & social security spending, and “erosion of governance”.  

Those asking what this means for the stock and bond market have pointed to the 2011 S&P downgrade and the ~15% fall in S&P 500 value over the subsequent two months.  In theory, a lower sovereign credit rating should increase the interest rate that the US treasury needs to offer investors to lend them money.  Since corporate bonds typically add a risk premium on top of US treasury yields, a downgrade should theoretically also increase corporate borrowing costs and slow economic growth.  In practice, however, that is not always the case.  US borrowing costs fell after the 2011 downgrade and remained low for the subsequent 10+ years – only meaningfully rising above those levels in mid-2022.  Similarly, Japan, which is rated ‘A’ and is in worse financial shape than the US has the lowest interest rates in the world.  Fitch had warned of the potential rating downgrade during the debt ceiling debate earlier this year and the issues that it pointed out are well known by the bond market.   

While the downgrade may have little near-term impact, it should stand as a warning to policy makers and the market that ongoing deficit spending and political brinksmanship will potentially come at a cost.  That cost may be the erosion of the “exorbitant privilege” that the US enjoys as the world’s reserve currency.  Global trade conducted in U.S. dollars has allowed capital to consistently flow into US capital markets and kept borrowing costs for the US government and corporations low.  Waning confidence in the fiscal responsibility of the US government may eventually erode this privilege.      

 
What We’re Reading:

yahoo!finance: Warren Buffett is Buying Treasuries Regardless of US Downgrade by Fitch

CNN: Gasoline prices are spiking.  That’s a problem for Powell and the FedWSJ: Earnings Season Threatens Lofty Stocks

Chart of the Week:

                Source: Congressional Budget Office: The Budget and Economic Outlook: 2023 to 2033  

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