On August 1, Fitch Ratings, one of the big three credit rating agencies, including Standard & Poor and Moody’s, announced it was cutting the long-term rating of U.S. Treasuries from AAA+, the highest rating in the land, to AA+. To many, the decision recalled memories of when the S&P downgraded U.S. Treasuries by the same measure in August 2011.  The surprising downgrade sparked a market decline the following day and ignited responses from investors, market strategists, economists, the White House, and the Treasury Department.  

Fitch’s downgrade reflects their view of expected fiscal deterioration over the next three years, a growing general government debt burden, and the erosion of governance that has manifested in repeated debt limit standoffs and last-minute resolutions.  

Most market participants are shrugging off the downgrade and heavily criticizing Fitch’s decision. After all, Moody’s continues to give the U.S. its highest rating.   Those opposed to Fitch’s decision cite an economy that continues to grow despite elevated inflation (currently 3.0%, down significantly from 9% in June 2022), eleven rate hikes from the Fed, and numerous other challenges like filling jobs nationwide.  While some arguments against lowering our debt rating have merit, others do not.    

Some of what Fitch said in its rationale for the downgrade didn’t strike me as critical, although I think their primary concern is the trajectory of debt against a backdrop of slower economic growth. With higher interest rates, servicing that debt is becoming increasingly expensive.  For example, current interest payments on more than $25 trillion in federal debt are around $700 billion annually.  With higher interest rates, many economists project interest payments to approach $1 trillion within a year.   I’m still trying to wrap my head around $25 trillion, let alone $1 trillion in interest costs!  The numbers are staggering and incomprehensible to most people.    

It shouldn’t surprise us that any of the big three rating agencies downgraded our pristine credit. It’s a wake-up call to our lawmakers in Washington, and I hope they understand the significance of what Fitch said and did. As consumers, we know that continually increasing our credit card limit and borrowing up to the maximum will likely result in a lower credit score.  Why should we view our country’s credit any differently?  The only difference is we can’t print money like our government!       

While economists and policymakers argue over the merits of the downgrade, investors are concerned about how the downgrade may impact long-term interest rates and financial markets. Longer term interest rates had already been climbing because of the better-than-expected second-quarter GDP report, showing our economy continues growing despite numerous warnings of an imminent recession. As short and long-term interest rates rise, it may put more pressure on consumers and businesses wanting to borrow, which in turn can negatively affect economic growth.    

So, how should investors interpret the downgrade? Are any actions necessary in response? Here are some thoughts: 

Remain calm & focused. The stock market has had one of the most substantial seven-month periods in years, and it’s occurred with below-average volatility.  We have had the fewest days with 1% moves up or down in the past five years.  We know this won’t last indefinitely, but I don’t think it will result in any continued downdraft. 

Stay fully invested. There is no reason to make wholesale changes to a thoughtfully-constructed investment plan.  It’s not unusual for markets to react negatively to unexpected news it deems concerning, at least initially.  However, markets decipher information quickly and move on.  Based on how markets closed last week, it seems the focus is on corporate earnings and inflation trends.    

We position client portfolios to help meet current or future spending goals. Historically, markets have experienced many gyrations to economic and geopolitical events, and it’s always come out on top–if you allow it to.      

Treasuries are safe. Despite the downgrade, government bonds are the world’s safest and most liquid securities. They are recognized worldwide as the preeminent government security because of our financial strength and economy.  Our government debt remains the gold standard, which won’t change because of Fitch’s decision.    

At Bloom Advisors, our bond allocations have historically included Treasuries and other government debt as well as other high-quality bonds to help mitigate stock market volatility and generate income. We’ve always employed a highly diversified bond mix across several bond types that benefit from rising or falling interest rates. We remain comfortable with our bond mix and have no adjustments planned at this time.

The bottom line is that the initial shock of the Fitch downgrade will eventually fade (maybe it already has), and markets will move to other worries, such as whether the Fed can successfully achieve a soft landing. Can they do the impossible—beat inflation and avoid an economic recession?  However, the more serious undertone is the constant political jockeying and lack of cooperation to tackle our long-term debt and deficit imbalance issues.  I hope this recent downgrade fosters less brinksmanship and more action to restore confidence here and abroad.    

Ultimately, the debt downgrade adds uncertainty and maybe a healthy dose of market volatility.  It is not good news, but it should hardly be at the top of issues keeping investors up at night.