Fitch Downgrades US Credit Rating Amid Worries Over Fiscal Deterioration

Fitch Ratings downgraded the United States of America's long-term foreign-currency issuer default rating to AA+ from AAA amid expectation of fiscal deterioration over the next three years.

The rating downgrade of the United States also reflects 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 said in a statement.

Fitch, which removed the Rating Watch Negative and assigned a Stable outlook, affirmed the Country Ceiling at AAA.

Below are the key highlights from Fitch’s rating action on the United States:

Erosion Of Governance

• 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. The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management.

Rising General Government Deficits

• The general government deficit is likely 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.

• In addition, the 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.

• Fitch expects a general government deficit of 6.6% of GDP in 2024 and a further widening to 6.9% of GDP in 2025. The larger deficits will be driven by weak 2024 GDP growth, a higher interest burden and wider state and local government deficits of 1.2% of GDP in 2024-2025 (in line with the historical 20-year average).

General Government Debt To Rise

• 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 general government debt-to-GDP ratio is projected to rise over the forecast period, reaching 118.4% by 2025.

Medium-Term Fiscal Challenges Unaddressed

• Over the next decade, 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.

• The Congressional Budget Office (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.

Fed Tightening

• The Federal Reserve raised interest rates by 25 basis points in March, May and July 2023. Fitch expects one further hike to 5.5% to 5.75% by September.

• 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% year-on-year. This will likely preclude cuts in the Federal Funds Rate until March 2024.

Economy To Slip Into Recession

• Fitch expects tighter credit conditions, weakening business investment, and a slowdown in consumption will push the US economy into a mild recession in 4Q23 and 1Q24.

• The agency sees US annual real GDP growth slowing to 1.2% this year from 2.1% in 2022 and overall growth of just 0.5% in 2024.

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