"Just a Warning for Washington" The Impact of US Credit Rating Downgrade Seen on Wall Street

"It is merely a warning to Washington's political circles." "Any downturn in the market will be short-lived and shallow."

Despite the global stock markets showing a broad decline on the 2nd (local time) following the downgrade of the United States' sovereign credit rating by international credit rating agency Fitch, many analyses suggest that the impact will be 'limited.' This is because the economic conditions in the U.S. today are completely different from those 12 years ago when the New York Stock Exchange plunged double digits and the bond market was shaken within just a week. Some even criticize Fitch's recent decision as "bizarre and inept."

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The main reasons Fitch cited for downgrading the U.S. credit rating from 'AAA' to 'AA+' late the previous day were the long-standing political conflicts (governance) over raising the federal government's debt ceiling, anticipated fiscal deterioration, and the national debt burden. This is the first time since S&P in 2011 that a major international credit rating agency has downgraded the U.S. credit rating, which immediately affected Asian stock markets. Stock markets in Asia, including South Korea, Japan, Hong Kong, and China, all closed lower that day. After the Asian session closed, European and New York stock markets also showed simultaneous declines. In particular, the Nasdaq index, which is tech-stock heavy, fell by over 2%.

However, considering the recent rally in the New York stock market, today's decline is seen more as a process of profit-taking and overheating correction rather than the 'downgrade shockwave' experienced in 2011. The ripple effects confirmed in the New York bond and foreign exchange markets this morning were relatively minor. The Dollar Index, which measures the value of the dollar against six major currencies, continued its strength. Although U.S. Treasury yields rose, the fluctuations were small. There was no rapid selling or buying frenzy as feared. UOB Group analyzed, "U.S. Treasuries remain the most liquid and stable assets, so the possibility of massive sell-offs by investors is low," adding, "Diversification into non-dollar assets is driven more by geopolitical risks than by the downgrade."

Wall Street also unanimously assessed from the previous night that this credit rating downgrade would not have a significant impact on the market. JP Morgan Chase stated in a memo sent to investors late the previous night, "After the 2011 S&P downgrade, the Treasury market was highly volatile, but the economic foundation of the U.S. was very different then," and added, "We do not expect similar volatility in the coming weeks." At that time, the reduction in fiscal spending relative to GDP was 0.7%, whereas in 2023 it is only about 0.2%. The unemployment rate also differs significantly from the 9% range in 2011.

Chris Harvey, Head of Equity Strategy at Wells Fargo, also noted, "At the time of the 2011 S&P downgrade, the U.S. stock market was in a correction phase, credit spreads widened significantly, and interest rates fell in a 'risk-off' mode," adding, "Currently, we are in almost the opposite situation." He predicted, "Due to completely different macroeconomic environments, this downgrade will not have effects similar to those in 2011," and forecasted that "the market downturn will also be relatively short and shallow." Brook May, Managing Partner at Evans Maywells, said, "(The downgrade) is disappointing, but I do not think it will have a meaningful short-term impact on the economy." Mark Dowding, Chief Investment Officer at RBC BlueBay Asset Management, dismissed the importance of Fitch's downgrade, saying, "I do not see Fitch's downgrade decision as particularly significant."

During the S&P downgrade 12 years ago, U.S. stock prices fell by as much as 15% within a week. However, Wall Street also notes that the S&P 500 index rose over the following 12 months. Jason Ware, Chief Investment Officer at Albion Financial Group, pointed out, "Although stock prices dropped sharply immediately after the downgrade 12 years ago, it was ultimately confirmed to be a buying opportunity," and added, "There will not be many investors selling stocks due to this downgrade." He explained that this could also serve as a buying opportunity this time. Joashim Clement, Head of Liberum Capital, stated, "There is no alternative to U.S. Treasuries in the global bond market, and there is no significant risk of default over the next 10 years," emphasizing, "There is no reason to sell U.S. Treasuries or demand a risk premium. All of this is just a 'storm in a teacup' (a big deal that looks small from the outside)."

On the contrary, some voices question the timing of this credit rating downgrade. This is because expectations for a so-called 'soft landing,' where inflation is lowered without a recession, have recently grown stronger. Compared to the time when Fitch first placed the U.S. on 'negative watch' (May 24), current economic conditions have improved significantly in many ways. Wendy Edelberg, Senior Fellow at the Brookings Institution, a U.S. think tank, pointed out, "It is hard to understand how the current situation is worse than before the debt ceiling crisis was resolved." Clement also described the timing of the downgrade as "surprising." Former Treasury Secretary Larry Summers criticized it as "bizarre and inept," noting that the economy is stronger than expected.

Ultimately, this decision is interpreted as a strong warning to Washington's political circles. The chronic 'brinkmanship' tactics of both parties amid worsening national debt are ultimately damaging the U.S.'s fiscal credibility. Jason Furman, Professor at Harvard University, said, "The downgrade is more politically interpretable than economically driven." Managing Partner May also assessed, "This is merely a warning to Washington's political circles." It shows the reality that even the U.S., as the issuer of the global reserve currency, cannot avoid a decline in national creditworthiness if fiscal soundness deteriorates. There are concerns that further downgrades could further jeopardize the federal government's fiscal health. Moody's, one of the three major credit rating agencies, still rates the U.S. credit as the highest.

This content was produced with the assistance of AI translation services.