Fitch Downgrades U.S. debt
The biggest news for the economy this week will probably be the decision by Fitch to downgrade U.S. debt from AAA to AA+.
Fitch had three reasons for the downgrade – one related to the fact we only just avoided a default (again) with the persistent debt ceiling debate. They are also concerned about the level of U.S. government deficits (which are now running at over $1 trillion each year) and the impact that has for future spending and taxation.
We talked about some of this when the debt ceiling debate was happening. The U.S. government debt is already running at close to 100% of GDP, a level only previously seen after the second World War.
In fact, data shows the U.S. started running deficits consistently starting in the 70’s, and around the time that happened, the frequency of recessions dropped. This is a text-book economic result – where governments intervene to boost the economy ahead of recessions, and slow the economy as bubbles form. It’s one reason why we are in a rate cycle now – to smooth the economic boom-bust cycles that tend to naturally form.
However, these persistent deficits, combined with an aging population which is expected to add to Medicare and social security costs, have some forecasting U.S. debt will increase to 200% by 2050. That’s not unheard of: Japan was in a similar situation back in the 1990’s, and they now have debt to GDP over 250%.
The problem with all that debt is that, just like all of us, the government needs to pay interest to its lenders.
Japan has managed to continue to deficit spending to support their economy because their interest rates are so low. Luckily, for now, the average interest rate the U.S. government needs to pay on debt is also still pretty low too.
However, if inflation doesn’t recede, and debt keeps growing, it’s possible net U.S. government interest costs could more than quadruple to 7.2% of GDP by 2052, That would soak up nearly 40% of federal revenues – compared to around 10% today – which would necessitate much higher taxes or much lower government spending.
In theory, if the U.S. debt is less secure, the interest rate the world charges us should go up too.
We did see U.S. interest rates spike this week. The 10-year Treasury yield increased to the highest level since last November – and well above the 3.5% level it spent a lot of this year at. Today it is almost 4.2%.
That could start to create headwinds for stocks again – just like we saw in 2022. Stock have been softer this week, with the Nasdaq falling around 3% so far.
Higher rates could also be due to jobs numbers
Although the rising U.S. interest rates could also be due to this week's jobs numbers – which were relatively strong. Layoffs and new jobless claims fell. Although manufacturing sector lost workers, leisure and hospitality hiring continued to grow.
Earnings data shows consumer companies still growing too
We are seeing a similar story from company earnings too.
Consumer sectors are still growing revenues and earnings. Leisure and Hospitality (Airlines, hotels, cruise ships) are helping industrials and consumer discretionary results.
However, the Manufacturing slowdown is affecting Energy and Materials companies. Thanks to that, and a couple of other sectors, market-wide earnings are still tracking to fall around 7% over year – the third quarter in a row of contraction.
The information contained above is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. Neither Nasdaq, Inc. nor any of its affiliates makes any recommendation to buy or sell any security or any representation about the financial condition of any company. Statements regarding Nasdaq-listed companies or Nasdaq proprietary indexes are not guarantees of future performance. Actual results may differ materially from those expressed or implied. Past performance is not indicative of future results. Investors should undertake their own due diligence and carefully evaluate companies before investing. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED. © 2023. Nasdaq, Inc. All Rights Reserved.
