Fitch Ratings has warned it may downgrade the United States’ AAA credit amid a worsening showdown over the country’s debt limit.
The agency late Wednesday put the nation’s issuer default rating on rating watch negative. The warning comes as Washington has been unable to reach a deal to avoid breaching the nation’s $31.4 trillion debt limit, and remains on a path to run out of borrowing capacity as early as June 1, the so-called X date.
The move to rating watch negative is the first concrete action from a ratings agency during the current political impasse. In 2011, S&P Global Ratings cut the U.S. credit to AA-plus from AAA during a similar standoff.
A downgrade of the U.S. sovereign would reverberate throughout the municipal bond market, carrying both near-term effects like higher borrowing costs and longer-term consequences like fewer federal funds for municipal credits.
“Fitch still expects a resolution to the debt limit before the X-date,” the agency said in its report. “However, we believe risks have risen that the debt limit will not be raised or suspended before the X-date and consequently that the government could begin to miss payments on some of its obligations. The brinkmanship over the debt ceiling, failure of the U.S. authorities to meaningfully tackle medium-term fiscal challenges that will lead to rising budget deficits and a growing debt burden signal downside risks to U.S. creditworthiness.”
The White House and Republicans met again Wednesday but the talks seemed to yield little. House Speaker Kevin McCarthy, R-Calif., said after the meeting that he does not expect a default but also that the two sides remain far apart.
In a later appearance on Fox Business, McCarthy sought to reassure rattled investors.
“I would not, if I was in the markets, be afraid of anything in this process,” McCarthy said. “We will come to an agreement when we get it, worthy of the American public, and there should not be any fear.”
Fitch also noted that governance in the U.S. is “a weakness” compared to its AAA-rated peers.
“The contested 2020 presidential election, brinkmanship over the debt limit to advance political agendas, and failure to reach consensus on the country’s fiscal challenges are recent signs of the deterioration in governance,” the agency said. “Political partisanship has brought about repeated debt-limit brinkmanship and led to near-default episodes that could erode confidence in the government’s repayment capacity.”
Fitch named several actions that could lead to a downgrade, including if Congress doesn’t raise the debt ceiling and the U.S. prioritizes debt payments but fails to meet other financial obligations, or if the debt limit is raised or suspended beyond the short term but “a significant and sustained rise in the general government debt/GDP ratio and/or a decline in the coherence and creditability of U.S. policymaking” restricts the nation’s financial flexibility.
A downgrade of the U.S. sovereign would reverberate throughout the municipal bond market. The most immediate downgrades would be to debt directly linked to the federal government, such as housing bonds, grant anticipation revenue bonds – which are secured by federal transportation grants – and military housing bonds. Pre-refunded bonds that have an escrow set up with Treasuries could also take a hit.
Earlier this month, Moody’s Investors Service outlined potential impacts in case of a downgrade. Low-rated credits would feel the heat from market volatility even if a deal is reached while the “vast majority” of state and local governments would be resilient, Moody’s said.