Credit rating agencies, such as Fitch, Moody’s, and Standard & Poor’s, provide ratings of the creditworthiness of debt issuances (from sovereign nations, municipalities, and corporations) as a tool for investors.
These ratings generally range from a high of AAA to D, with ratings below BBB- often considered “non-investment grade” or “junk”. On May 16th, Moody’s cut the U.S. credit rating from AAA, the highest rating that represents minimum credit risk, to AA1, which is the notch below, but still represents high-grade credit worthiness. The rating scale, running from a high of AAA to a low of C, comprises 21 notches. It is divided into two sections, investment grade and speculative grade. As one moves down the rating scale, default risk rises.
Moody’s cited widening budget deficits, deteriorating debt affordability, and concerns about the commitment of elected officials to alter the trajectory for rising U.S. debt. “This one-notch downgrade on our 21-notch rating scale reflects the increase over more than a decade in government debt and interest payment ratios to levels that are significantly higher than similarly rated sovereigns,” the rating agency said in a statement. They continued, “Successive U.S. administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs. We do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration.”
The historic default rate for AAA-rated debt issuers is negligible, across all horizons. Even though the U.S. has been downgraded from the highest rating, the chances of a default on outstanding U.S. debt are relatively low. The implications of a credit downgrade may see yields increase (not materially as a lot of this has already been priced in) for longer-term U.S. Treasuries which could put pressure on equity valuations. While the long end of the curve is increasingly influenced by fiscal dynamics, expectations for Fed policy will continue to drive the front end of the Treasury curve. Overall, the downgrade underscores deepening concerns about the fiscal discipline of the U.S. and brings forth the question of “How much longer can this fiscal irresponsibility continue?”
Source: Ratings.Moodys.com/ratings-news/443154
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