Mitch Zacks: What Will be the Impact of the U.S. Credit Downgrade?

Mitch digs in to Fitch's recent downgrade of U.S. credit, which it based on the recent debt ceiling drama, CBO debt and deficit forecasts, entitlements, and other areas of concern. [Mitch on the Markets] What to Make of Credit Downgrades for the U.S. and Its Banks In early May, the company Fitch Ratings put out a press release warning of a potential downgrade to the U.S.’s sterling AAA credit rating. Fitch was responding to the debt ceiling drama as it unfolded, attaching its name to the largely misguided narrative that the U.S. was charging towards a debt default.1 Now, nearly two months after a debt ceiling deal was struck – and with worries about debt default gone – Fitch made its splash in the news cycle by lowering its rating on the U.S. to AA+, one notch down from the top AAA grade. If investors were expecting the downgrade to be accompanied by new revelations about the U.S.’s fiscal standing, they were greatly disappointed. Instead, Fitch Ratings cited the debt ceiling drama, Congressional Budget Office debt and deficit forecasts, Social Security and Medicare funding, the 2017 tax cuts, and high government spending as the causes for concern. --------------------------------------------------------------- [Is Now a Good Time to Invest in the Market?]( Before attempting to answer this question, be sure to check Zacks' newly released [August Stock Market Outlook Report](. Today, Mitch on the Markets’ readers are invited to read it for FREE. This report contains some of our key forecasts to consider such as: - Top-down S&P500 yearend 2023 and 2024 targets - Zack’s view on equity markets - Setting U.S. returns expectations for 2023 - Zacks Rank S&P500 sector picks - Zacks rank industry tables - And more… If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today! [Download Our Just-Released August 2023 Stock Market Outlook Report 2]( --------------------------------------------------------------- In other words, it was a collection of information that markets and investors have long, long known and understood. To be clear, I do not intend to minimize problems the U.S. faces with mounting debt and interest payments. As seen in the chart below, total debt as a percent of GDP (blue line, left axis) has soared since the 2008 Global Financial Crisis, and remains above 100%. That’s too high. Additionally, interest payments as a percent of GDP (red line, right axis) are still benefiting from a prolonged period of low interest rates, but yields are rising – which means borrowing is becoming more costly. This dynamic of high absolute debt and rising interest rates can restrict the U.S.’s ability to borrow more in the future, which can crimp spending and investing – and therefore impact GDP growth. Debt as % of U.S. GDP (left axis) and Interest Payments as % of GDP (right axis) [MOTM_08122023_graph1] Source: Federal Reserve Bank of St. Louis 3 While I think debt and interest cost issues are worth monitoring, I do not think the opinions of ratings agencies should factor much into an investor’s decision-making process. In my view, they lack credibility. You do not need to look very far back in history to understand why. In the spring of 2008, Fitch gave Lehman Brothers’ preferred stock an A+ rating, about a month after Bear Stearns failed. Five months after receiving Fitch’s A+ rating, Lehman Brothers collapsed. A few years later, 2011’s ‘fiscal cliff’ drama gripped the headlines for months, and Standard & Poor’s – another ratings agency – made waves when they downgraded the U.S.’s debt rating from AAA to AA+. At the time, this felt like a huge deal that could impact the U.S.’s ability to borrow (issue Treasurys) at attractive rates. Logic would say that a debt downgrade should put upward pressure on the cost of borrowing, which would imply rising yields on U.S. Treasurys. But the opposite happened – yields fell after the downgrade. Yield on 10-Year U.S. Treasury Bond (2011) [MOTM_08122023_graph2] Source: Federal Reserve Bank of St. Louis 4 As a follow-on to Fitch’s downgrade of the U.S., Moody’s came out this week and cut the credit ratings on 10 regional banks, while placing six noteworthy financial institutions into ‘review.’ At first glance, many investors might have seen this news and thought that early spring’s bank stress was back. But it turns out that Moody’s downgrades were just a rehashing of the same issues that came to light months ago. In their report, Moody’s said that rising interest rates “continue to have a material impact on the U.S. banking system’s funding and its economic capital,” adding that higher rates are impacting the value of bonds and other assets on bank balance sheets, leaving lenders with “sizable unrealized losses.” Moody’s also cited risks that a recession could have on loan demand and called out issues in the commercial real estate markets like plummeting demand for office space. The market has known about these problems for months. Bottom Line for Investors Back in May, Fitch rightly characterized the U.S. missing a debt payment as a “very low probability event.” It seemed like an acknowledgment that the U.S.’s issues around debt and obligation payments were more of a political problem than an economic one, which I think is an accurate framing of the issue. But Fitch issued its downgrade anyway, citing other pieces of dated and widely-known information about taxes, entitlement programs, and CBO budget projections. It’s a delayed reaction based on old news, which I think renders its impact on markets and the economy as insignificant. An alternate telling of the U.S.’s credit and fiscal standing is not that far away, either. Both Standard & Poor’s and Moody’s continue to give the U.S. the highest possible rating. To get more insight into current market trends, I’m offering our exclusive, [Just-Released August 2023 Stock Market Outlook Report](. This report will give investors a deeper insight into: - Top-down S&P500 yearend 2023 and 2024 targets - Zack’s view on equity markets - Setting U.S. returns expectations for 2023 - Zacks Rank S&P500 sector picks - Zacks rank industry tables - And more… If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today! [Download our Just-Released August 2023 Stock Market Outlook 5]( About Zacks Investment Management Zacks Investment Management was born out of one of the country’s largest providers of independent research, Zacks Investment Research. Our independent research capabilities from our parent company truly distinguish us from other wealth management firms - our strategies are derived from research and innovation, including the proprietary Zacks Rank stock selection model, earnings surprise and estimate revision factors. At Zacks Investment Management, we work with clients with $500,000 or more to invest, and we use this independent research, 35+ years of investment management experience, and tools we’ve developed to design customized investment portfolios based on each client’s individual needs. The end result is investment management that is research driven, results oriented and client focused. Don't put off planning your secure retirement! Talk to a Zacks Wealth Advisor today. 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