Will the U.S. debt downgrade be a wake-up call?

Too much debt. Rising interest rates. Political standoffs.

Although Fitch Rating's move to lower the U.S. credit rating a notch down from AAA didn't make a major wave in domestic or global markets, experts caution against ignoring the reasons behind the decision.

"What Fitch is really saying is that the path the U.S. is on is unsustainable and going in the wrong direction," commented Steve Wyett, BOK Financial® chief investment strategist.

In the announcement, the credit rating agency said the U.S.'s downgrade to AA+ "reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to 'AA' and 'AAA' rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions."

"Those are just factual statements," Wyett said. "If you look at the pace that the U.S. government is adding debt, particularly as we came through the pandemic, it's increasing at a rate that is mathematically a bad position to be in."

Since politicians lifted the U.S. debt ceiling in June, the national deficit has increased by $1.2 trillion. Meanwhile, interest rates have been rising, which makes it more expensive for every borrower—including the U.S. government—to have debt.

Impact on global borrowing

The nation's AA+ credit rating could make it more expensive for the country to borrow money, said Peter Tibbles, senior vice president of foreign exchange for BOK Financial.

"Some investment vehicles can only buy AAA paper. Now that some investors cannot buy certain U.S. Treasuries, that means that some demand has gone," said Tibbles. "That tells me that the U.S. is going to be paying higher interest rates on future issuance for their debt."

That will increase the amount of interest the government pays on the national debt, which will also impact the federal government's budget, Wyett said. Already, net interest made up 9%—or $525 billion—of the U.S. government's 2024 fiscal year budget, and that number is growing. "If you're throwing higher credit risk on top of higher interest risk, it's a detriment to your fiscal budget."

Fitch's decision also could increase borrowing costs for borrowers around the globe, Wyett noted.

"U.S. Treasuries are considered to be the safest, most creditworthy asset class out there. Everything other than that has some additional measure of risk to it, so if Treasuries move higher in risk, then every other asset class moves higher in risk as well," he explained.

"Ultimately, it could make it more expensive for emerging markets to borrow money, as many emerging market countries peg the value of their currency to the dollar. China does that, too."

2011 downgrade

Fitch's recent move marks the second time the U.S. credit rating has been downgraded. In 2011, Standard & Poor's also downgraded it from AAA to AA+. "They've never raised it back," Wyett said.

“For both Fitch and S&P to raise it, they would have to see improvements in our annual budgeting process, reductions in our debt-to-GDP ratios and that our political system is working more closely together.”

- Steve Wyett, chief investment strategist

It will take "more political teamwork" in Congress for the U.S. to receive a AAA rating again from those agencies, Tibbles agreed. "Congress has got to start thinking about ways of, if not reducing the debt, then certainly cutting back the pace at which we're adding to it. Both parties have got to do something to alleviate that."

Wyett noted the U.S. likely will have to both raise taxes and cut spending in order for the nation to slow the pace at which it's accumulating debt.

"Our fiscal situation is not dire," Wyett said. "We're not going to default on our debt. But the longer the current situation goes on, the more difficult the problem will be to solve because the spread between spending and revenue will just keep getting wider and wider, which will just make it harder and harder to get on the right path."

"I don't see the downgrade being a huge factor right now," Tibbles agreed.

“It’s more of a shot across the bow—a warning sign to start thinking about what we’re going to do with this debt and how we can bring it under control.”

- - Peter Tibbles, senior vice president of foreign exchange