Fitch lowered the credit rating of the United States. Is it time to reduce the holdings of U.S. debt and de-dollarization?

Fitch, one of the three major international rating agencies, challenged the Biden administration to lower the US long-term foreign currency issuer default rating (IDR) from “AAA” to “AA+”. Fitch said the move was due to the deteriorating fiscal situation in the United States, sinking in the quagmire of debt, while the political gridlock showed weak governance. Although such incidents are uncommon, they are reasonable, just like an honest child exposing the “emperor’s new clothes” with one word, making the truth shocking.

U.S. credit rating downgraded again

Fitch’s downgrade of the U.S. credit rating this time is the second time in U.S. history that government credit has been cut. The last time was 12 years ago.

In 2011, Standard & Poor’s lowered the sovereign rating of the United States from 3A to 2A+. At that time, the market caused huge waves, and the US stock market plummeted 7% that day. However, this downgrade has relatively limited impact on the market. Gold only opened slightly higher on the second day, and then returned to a stable level, which seems to imply that the market has already sensed the approach of the gray rhinoceros.

Compared with 12 years ago, the current situation is significantly different in two ways. First, the timing is different. The downgrade of the US credit rating in 2011 coincided with the fierce partisanship, and the debt ceiling issue was hotly discussed, which caused a huge impact and turbulent waves. But the downgrade came two months after debt-ceiling negotiations were completed, and people have faded into oblivion.

Second, we are in a very different global monetary environment than we were 12 years ago. In 2011, the United States was immersed in a loose monetary atmosphere, and the Federal Reserve continued to implement large-scale quantitative easing policies, and the market sailed. Now that the United States is in the midst of a monetary policy tightening cycle, there are too many negative news to worry about, and it doesn’t matter if there are more ones. The downgrade only sends a negative signal to the Fed for the U.S. economy and accelerates the end of the Fed’s interest rate hike cycle.

Why Fitch Downgraded U.S. Ratings

As for the motivation behind Fitch’s downgrade, various speculations are intertwined in the fog. Perhaps, some people think that Fitch and the US government are performing an exquisite double play, the purpose of which is to pave the way for the depreciation of the dollar, create an atmosphere of depreciation, and then quietly stage a scene of global entanglement.

However, such a conjecture or explanation is dubious. One of the keys is how to understand the importance of ratings. Ratings, which determine the level of financing in a country’s market, are by no means child’s play. For small and weak countries, ratings may push them into the abyss; for large countries, this cannot be ignored. Once the rating is downgraded, it may lead to doubled risks in the financial market.

In this intricate international economic chess game, people can’t help but fall into the confusion of reasoning, and the answer seems to be far away. There appears to be a plausible explanation for Fitch’s enigmatic motives, revealing a complex and confusing picture.

First of all, this may be to achieve multiple purposes through relegation. From a financial point of view, once one of the three major rating agencies downgrades the rating, the market will regard it as a downgrade. This sentiment is widespread and understandable. In the financial market, negative news often has a greater impact than positive news. After all, investors are unwilling to ignore risks, and short sellers will not miss the opportunity to short. 90% of the business in the global rating market is monopolized by the three major rating companies Moody’s, S&P and Fitch, so their right to speak is extremely important and can influence the global capital market. They also use their influence to influence the market for profit. Take Moody’s as an example. From 2000 to 2007, Moody’s awarded more than 40,000 mortgage-related assets with 3A ratings, resulting in a business revenue of US$2.2 billion. However, when the financial crisis came in 2008, Moody’s hastily downgraded these innovative financial products, amplifying the crisis effect and becoming an accomplice of the crisis. A Moody’s executive once said helplessly: “In order to make money, we sold our souls to the devil.”

Compared with the other two institutions, Fitch is smaller, so its strategy is more aggressive, and it does not hesitate to compete for eyeballs to seize market share. Looking back at the Greek debt crisis in 2009, Fitch was the first to downgrade Greece’s national credit rating. I have to admit that releasing news, triggering market turmoil, and making huge profits are what Wall Street is good at.

Perhaps Fitch has another motive hidden, which is to prevent Trump from returning to the White House. U.S. Treasury Secretary Yellen and many other government officials publicly opposed Fitch’s downgrade of the U.S. credit rating, emphasizing that Democratic President Biden should not take the blame for the Republican Party and former President Trump. In fact, the U.S. government tried to persuade Fitch to abandon the downgrade, but the other party insisted that the key reason for its decision was the unrest caused by Trump and his supporters storming the Capitol in early 2021, which highlighted the political instability in the United States.

At present, a considerable number of Europeans are disgusted with Trump, and Trump’s arrogant attitude towards Europe during his term of office has made many Europeans furious. However, according to the current pre-election situation in the United States, Trump is expected to become the final candidate of the Republican Party again, competing with Biden for the 2024 presidential throne, and he also has a considerable chance of winning. Under such circumstances, taking Trump supporters’ attack on the Capitol as a key factor for downgrading the US sovereign rating will undoubtedly help to increase public concerns about Trump’s election.

However, Fitch’s calculations don’t quite line up with the Biden administration’s expectations. Although the Biden administration also agrees that Trump’s re-election may bring risks to the US economy, the impact of the downgrade on the US economy is even more serious. The latest report from the Federal Reserve showed that the gap between the yields of 2-year and 10-year Treasury bonds in the US Treasury market reached the highest level in 40 years, which sent a strong warning of economic recession. In addition, the health of the manufacturing industry has deteriorated sharply, and high inflation will also have an impact on residents’ income, thereby reducing consumption capacity. If the U.S. economy experiences a severe recession before the 2024 general election, not only will it not assist Biden’s election, but it may even become a drag.

Therefore, the downgrade of the U.S. credit rating may be negative news deliberately released by Fitch, which is likely to be accompanied by a series of operations that harm others and benefit itself. The impact of this on U.S. debt is actually not huge. After all, U.S. treasury debt has never substantially defaulted. Although the motive behind Fitch’s downgrade is full of fog, the situation cannot escape a clear eye after all, and the truth will eventually be revealed slowly.

What kind of “chill” may be released by the “downgrade” of the United States

It remains to be seen what impact Fitch’s downgrade will have on the U.S. and the global economy, and its potential large-scale side effects may not appear in the farther future.

First, Fitch’s move could reignite a bitter bipartisan row over fiscal issues. The government budget for the upcoming fiscal year 2024 has already sparked deep partisan divides, signaling a possible repeat of the annual federal government shutdown.

Second, Sino-US relations may usher in new opportunities for improvement. Wall Street investment banks predict that the scale of U.S. debt will exceed $32 trillion nine years ahead of the forecast before the new crown epidemic. U.S. real GDP growth is expected to slow to 1.2% in 2023 from 2.1% in 2022, and further to 0.5% in 2024. The U.S. government faces a series of economic difficulties, which may be one of the reasons why it hopes to improve relations with China in the near future. However, the tough rhetoric against China in the United States has also led to contradictory policies of the Biden administration, sending quite confusing signals. If the U.S. economy is in trouble, it may create new opportunities for the improvement of Sino-U.S. relations.

Third, we need to be alert to the possibility that “the epicenter is in the United States, but the damage occurs in peripheral countries and regions”. On August 1, Fitch unexpectedly lowered the credit rating of the United States, and the market risk sentiment was hit. On the 2nd, investors rushed to take profits, and the Asia-Pacific market plummeted. The Asia-Pacific stock market index recorded the largest drop in the past month, Hong Kong stocks and A-shares both fell, and the Hang Seng Technology Index fell more than 3% intraday. Markets such as Japan, South Korea, Vietnam, India, and Indonesia all fell, while oil prices and gold prices rose to a certain extent.

In general, Fitch’s downgrade may just be the beginning of chills, and it will take time to reveal the large-scale side effects. The interplay between politics, economics, and international relations could trigger broader ripple effects, so we need to keep an eye on these dynamics.

Although the impact on Fitch’s downgrade remains to be seen, the US government’s “retaliation” against Fitch may come soon. A historical review points to 2011, when Standard & Poor’s downgraded the US sovereign credit rating, and the US government reacted strongly. The U.S. Department of Justice dug up old accounts and launched an investigation into S&P on the grounds of illegal operations in 2008. Under this pressure, Sharma, president of S&P, was forced to resign, and the post of president was replaced by Peterson, chief operating officer of Citibank. Sharma’s resignation reflects the game between politics and finance. However, the US government did not end its pursuit of S&P. In February 2013, the U.S. Department of Justice sued Standard & Poor’s again, claiming that it increased profits and manipulated ratings, exacerbating the 2008 financial crisis, resulting in losses to banks and credit unions guaranteed by federal deposits, and demanding $5 billion in compensation from Standard & Poor’s. In February 2015, the U.S. government and S&P reached an out-of-court settlement, and S&P finally settled the case by paying a fine of US$1 billion.

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