We were a “one café” town. Not only did my hometown not have a stop light, but it only had one café at a time. You ate there even if you didn’t like the food because it was the only option in town. This very much describes the recent downgrading of US bonds. The world may not like them, but they are still their best option.
On August 1, Fitch, one of the three main credit rating agencies, downgraded US government debt to its second-highest rating, AA+. Their reasons were an expected economic weakening over the next three years and “a high and growing general debt burden.” No one was surprised because Fitch announced in June that they were considering it and, frankly, had been threatening a downgrade for years.
I agree the US Government does have a debt problem, and its debt has been piling up at a crazy pace over the last 25 years. Their recent big-ticket items include an expensive war on terror, a very expensive response to the financial crisis, and an extremely expensive response to the pandemic. The amount of money the US government spends on its debt interest is going up quickly because of the Federal Reserve’s interest rate hikes. If things don’t change in 10 years, the US could reach a point where 80% of its tax revenue is used for interest payments.
Before you say I’m pointing fingers at one political party, let me tell you both parties caused this mess. Both Republicans and Democrats have their fair share of financial idiots in elected offices. Pardon me while I step back off my soap box.
So how do we fix it? The US will have to raise taxes by a lot and cut spending by a lot. Unfortunately, there is only so much we can cut. Even this year, the debt interest uses up three-quarters of its non-social service and non-defense spending. We have a spending problem. Since 1973, non-defense spending has increased 75% faster than defense spending, according to the Cato Institute. But we are so far in debt now that it will take more than just spending cuts to get us out of this; it will now take aggressive tax increases and spending cuts.
This Fitch downgrade reminds us of August 2011 when Standard & Poor’s downgraded the US government’s credit rating. Some investors got nervous with the Fitch news that markets might repeat that 2011 big market drop of almost 20%. This time the market wasn’t surprised; the S&P 500 fell about 2% during the three days following the news.
Fitch is probably right in its assessment, but the rating downgrade itself probably won’t have much impact on the government bonds or markets broadly because where else would investors go? The US continues to be the safest “safe haven” during times of market stress, and the downgrade won’t change that. But the US still needs to put its financial house in order; if it doesn’t, we’ll likely see more downgrades.
We all know the US has a debt problem and didn’t need Fitch to tell us that. But what Fitch did, and S&P before them, was to shine a light on the need for the US to fix its debt problems. Like other things, the longer Congress waits, the more difficult the problem becomes to manage.
My grandma occasionally took me to our town’s only café for pancakes. It wasn’t the cleanest of restaurants, and now that I’m almost a germophobe, I don’t think I could handle it. But the whole town ate there because it was the only option in town. The US bonds are the same way, they may not have a perfect rating but they are still the best available option and that makes me feel better about the market.
Have a blessed week!
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Government bonds and Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
The economic forecast outlined in this material may not develop as predicted & there can be no guarantee that strategies promoted will be successful.
Fervent Wealth Management is a financial management and services entity in Springfield, Missouri.