Fitch Downgrades US Long-Term Ratings To AA+; Expects One More Hike By September From Fed

Fitch Ratings has downgraded the United States' long-term Foreign-Currency Issuer Default Rating (IDR) to 'AA+' from 'AAA'. However, the Rating Watch Negative was removed and a 'Stable' outlook was assigned. Meanwhile, the country's ceiling has been affirmed at 'AAA'.

In its statement, Fitch said, "The rating downgrade of the United States 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."

Further, in Fitch's view, there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025.

Meanwhile, Fitch expects the general government (GG) deficit to rise to 6.3% of 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.

In regards to Fed tightening, Fitch expects one further hike to 5.5% to 5.75% by September.

It added, "The resilience of the economy and the labor market are complicating the Fed's goal of bringing inflation towards its 2% target. While headline inflation fell to 3% in June, core PCE inflation, the Fed's key price index, remained stubbornly high at 4.1% yoy."

This will likely preclude cuts in the Federal Funds Rate until March 2024. Additionally, Fitch added, the Fed is continuing to reduce its holdings of mortgage-backed securities and U.S. Treasuries, which is further tightening financial conditions. Since January, these assets on the Fed balance sheet have fallen by over $500 billion as of end-July 2023."

The American credit rating agency has factored a GG deficit of 6.6% of GDP in 2024 and a further widening to 6.9% of GDP in 2025.

As per Fitch, lower deficits and high nominal GDP growth reduced the debt-to-GDP ratio over the last two years from the pandemic high of 122.3% in 2020; however, at 112.9% this year it is still well above the pre-pandemic 2019 level of 100.1%. The GG debt-to-GDP ratio is projected to rise over the forecast period, reaching 118.4% by 2025.

That being said, the debt ratio is over two-and-a-half times higher than the 'AAA' median of 39.3% of GDP and 'AA' median of 44.7% of GDP.

Fitch's longer-term projections forecast additional debt/GDP rises, increasing the vulnerability of the U.S. fiscal position to future economic shocks, it said.

In US, over the next decades, Fitch believes that higher interest rates and the rising debt stock will increase the interest service burden, while an aging population and rising healthcare costs will raise spending on the elderly absent fiscal policy reforms.