White House hits back at US downgrade

Red lights flashed across the world’s stock markets today after the Fitch ratings agency downgraded the US government’s credit rating from its top notch AAA score to AA+, citing “fiscal deterioration” over the coming years.

The Fitch report also claimed the US had seen a “steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters”. It’s a big move by Fitch as its rating scores are used by investors to assess the risk profile and credit worthiness of companies and governments when they raise finance in the debt capital markets.  

As expected, US Treasury Secretary, Janet Yellen, was quick to dismiss the Fitch downgrade as “arbitrary” and based on outdated data. Yellen added that Treasury securities remain the world’s preeminent safe and liquid asset, and that “the American economy is fundamentally strong.” 

Many top US economists agreed with her. Former US Treasury Secretary Larry Summers described Fitch’s decision as “bizarre and inept,” particularly as the US economy “looks stronger than expected.” So did Mohamed El-Erian, chief economic adviser at Allianz, who said the Fitch rerating was “a strange move”, adding it is more likely to be dismissed by investors than have any disruptive impact on the US economy, or indeed the markets.

And Nobel Prize-winning economist Paul Krugman said: “The biggest economic news over the past year has been America’s remarkable success at getting inflation down without a recession”.

Even so, stripping the world’s biggest economy of its top tier triple A gold star comes at a fragile time as concerns rise over the Biden administration’s gigantic spending package, and only two months after the US came close to defaulting on its debts. 

Although the Republicans and Democrats went to the wire in the debt negotiations, they did manage to strike a deal to raise the US federal government’s $31.4 trillion legal borrowing limit. However, fears persist that this may unravel in the autumn. 

This didn’t stop Fitch from hammering home its gloomy message, claiming the US “lacks a medium-term fiscal framework”, with the suggestion that this sets it apart from other leading economies and that the constant debt stand-offs are a problem. Tough talk indeed.

It’s no surprise that the latest warning – coming with the forecast that the US might tip into recession next year – triggered alarm bells around the globe that the country is losing steam as it continues hiking interest rates to control inflation.

On the London Stock Exchange, the FTSE 100 and FTSE 250 indexes slumped by more than one per cent while on the continent, the Euro Stoxx 50 was down nearly two percent after heavy falls in Asia and Hong Kong. In the US, both the Dow Jones Index and Nasdaq opened nearly two per cent down.

In the UK, investors are jittery ahead of the Bank of England’s meeting tomorrow onvinterest rates. The Monetary Policy Committee has now hiked rates 13 times in a row, and looks likely to push them up again to 5.25 per cent or even by 0.5 percent. 

But there is a strong case that the MPC should take a breather, particularly after the poor manufacturing figures for July – which have fallen to a seven-month low – and the sharp decline in house prices. Half-year results today from house builder Taylor Wimpey showed again how higher mortgage rates are already biting, with pre-tax profit almost halved as it sold fewer houses. 

The Old Lady has a big decision to take: should she raise her skirts to knee-level or keep them at midi-length? If the MPC – which now has four women on board for the first time ever – is sensible, she should pause, and hold rates where they are, wait and watch. 

The MPC should remember that it takes two years for higher rates to bite and that households need time to readjust. Alternatively, if she raises her skirts too high, she may pitch us into recession. Time to keep cool as inflation is coming down.  

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