'Likely to be dismissed': Observers see few immediate effects from second downgrade of US credit in history

Fitch downgraded the US government's top credit rating Tuesday from AAA to AA+ and provoked a widespread response in Washington and across the investing community.

But amid anger at the ratings agency for its methodology and a predictable partisan blame game that ensued, there were low expectations in the immediate aftermath that the downgrade would change the state of play in Washington.

That looked like the reality, even as Wall Street plunged on Wednesday — and as Fitch cited increasing government polarization, including the Jan. 6 insurrection, as a key factor in its rating cut.

Lawmakers are currently headed toward a government shutdown this fall in what could be yet another display of Washington dysfunction, with parallel efforts to head off the next debt limit fight in 2025 moving at a snail’s pace.

"This announcement is much more likely to be dismissed than have a lasting disruptive impact on the US economy and markets," noted Mohamed A. El-Erian, chief economic advisor at Allianz and president of Queens’ College, University of Cambridge.

Indeed, the Biden administration immediately waved away the move with Treasury Secretary Janet Yellen calling it "arbitrary and based on outdated data." Nevertheless, the ratings agency pointed to long-term fiscal challenges in making its change that Washington will need to address in the years ahead.

In addition, the Treasury department says they don't expect the rating change to impact US borrowing plans. Secretary Yellen said Tuesday the decision won't change the belief that "Treasury securities remain the world’s preeminent safe and liquid asset." On Wednesday, Josh Frost, Assistant Secretary for Financial Markets, added that “we continue to see robust demand for Treasury securities" and that he doesn't see it impacting the Department's ability to fund the government.

Michael Strain, the director of economic policy studies at the American Enterprise Institute, noted there may be plenty to quibble with around Fitch’s timing, but the move still points to underlying issues like an unsustainable fiscal trajectory and a US political system that “does not seem up to the challenge it faces.”

In its own statement, Fitch said "there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters."

A second downgrade

The move now means that two of the three major credit ratings agencies — Fitch and S&P Global Ratings — have downgraded the US credit rating.

Fitch’s move this week came two months after a debt ceiling deal in May staved off government default but only after lawmakers again brought the country to the brink. Similarly, the S&P downgraded the US credit rating in 2011 following a debt limit standoff that year.

The third rating agency, Moody’s, last rated US Treasuries at AAA with a stable outlook. It may be unlikely to follow Fitch’s move anytime soon.

Mark Zandi, the chief economist at Moody’s Analytics, said in a post Tuesday that he thought the Fitch move was "off-base" and was critical of the rating on a variety of fronts. Zandi does not oversee rating decisions at Moody’s Investors Service. Both are part of Moody's Corporation but operate independently.

The move drew a forceful response from the White House and other observers, who noted that Fitch’s own quantitative ratings model for US fiscal health has actually improved since Biden took office.

It "defies reality to downgrade the United States at a moment when President Biden has delivered the strongest recovery of any major economy in the world," White House Press Secretary Karine Jean-Pierre said.

"I am very puzzled by many aspects of this announcement, as well as by the timing," added El-Erian. "I suspect I won't be the only one."

Other observers criticized the rating agency’s methodology. Former National Economic Council Director Jason Furman said it was "hard to understand why the downgrade is coming now." Liberal economist Paul Krugman called the move "widely and correctly ridiculed."

A move that could amplify efforts to end future debt-ceiling fights

Fitch cited this spring's debt ceiling fight as a reason for the downgrade, saying "repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management."

Maya MacGuineas, president of the Committee for a Responsible Federal Budget, added praise of the May debt ceiling deal as a move in the right direction to get the nation’s fiscal house in order but added that since then "already there are signs of backsliding."

In recent months, some lawmakers have advanced plans to head off the next debt ceiling fight, with the White House last month announcing a debt limit working group led by National Economic Council director Lael Brainard to study the issue.

Biden has previously said that the idea of invoking the 14th amendment — which reads that "validity of the public debt of the United States ... shall not be questioned" — could be a legitimate if legally perilous approach in the future.

Lawmakers have also put forth plans on the issue, with Rep. Brendan F. Boyle (D-Penn.) saying Tuesday "we need to address the root cause of this downgrade" while pushing his plan to lower the stakes in future debt ceiling standoffs.

While it’s unclear if Washington will move forward on any of those debt ceiling efforts in the months ahead, what is much more likely is fiscal gridlock this fall. Lawmakers left Washington last week for their summer recess with little progress to show on efforts to avoid a government shutdown in under two months.

When they return to Capitol Hill in September, they’ll only have about three weeks until a Sept. 30 deadline to pass a federal budget and avoid a shutdown. Government shutdowns have historically had less economic impact than debt ceiling fights, but it will likely be yet another display of Washington’s dysfunction on fiscal issues.

Meanwhile, many lawmakers immediately turned to partisan politics following the move. Senate Majority Leader Chuck Schumer (D-N.Y.) said "Republicans need to learn from their mistakes" while House Ways and Means Committee chair Jason Smith (R-Mo.) blamed Biden, saying it was the president who "pushed America’s credit rating off the ledge."

House Speaker Kevin McCarthy didn't immediately respond to the downgrade but was instead focused on using Tuesday’s third indictment of former President Trump to attack Biden, saying "House Republicans will continue to uncover the truth about Biden Inc. and the two-tiered system of justice."

Ben Werschkul is a Washington correspondent for Yahoo Finance. Jennifer Schonberger contributed reporting.

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