The US rating has once again been downgraded below AAA, this time by Fitch. Recall that S&P’s downgrade (also to AA+) in 2011, which followed stalled debt ceiling negotiations, precipitated a spike in market volatility and a flight-to-quality rally that benefited…US Treasuries. The sharp decline in US Treasury yields following that announcement indicated that market participants didn’t question the willingness of the US to make good on its debts and reinforced the status of Treasuries as a safe-haven asset. Today’s market reaction is more muted, with yields modestly higher and some (including Treasury Secretary Yellen) questioning the timing of the decision.
While the timing of Fitch’s decision was never clear, the outcome has been a long time in the making due to constant willingness to pay issues and, more importantly, a deteriorating public-sector backdrop with no credible plan to put it on a sustainable trajectory over the next 10 years. While there do not appear to be many significant forced selling issues due to the loss of AAA status, I think this formal acknowledgment is important for several reasons.