August 2, 2023
Fitch explained its US credit rating downgrade as “expected fiscal deterioration over the next three years.” There was also a mention of governance issues related to this year’s debt ceiling standoff, but its really about an expected increase in the fiscal deficit relative to GDP. Fitch anticipates the fiscal deficit will increase to 6.4% of GDP this year from 3.7% in 2022. Fiscal spending from the IRA, Chips Act and infrastructure bill don’t help matters, but the increase in the deficit is better explained as a reduction in tax receipts, increased spending on SS benefits and Medicare due to COLA adjustments and higher interest on the public debt. Tax receipts are expected to be down $320B YoY in ’23 based on weakness in financial assets in 2022, this year’s extension of tax deadline in parts of CA and reduced remittances from the Fed. The first two issues should be temporary, while remittances from the Fed will likely be down for the next 2-3 years. On the spending side, future increases should slow based on more moderate inflation adjustments, but interest on the public debt will likely remain an issue unless we get a fairly steep recession.
At this point, the credit rating downgrade is more about sentiment than any kind of direct impact. And today’s sell-off may be better explained as de-risking into a seasonally soft patch and Fed-induced uncertainty. There may also be a macro catalyst hangover effect following a frenzied week of China stimulus expectations, the BOJ policy tweak and incrementally dovish Fed meeting. US investors still have Friday’s Jobs Report and next Thursday’s CPI print to look forward to, but the catalyst calendar from a global perspective gets a little thin until the Fed’s Jackson Hole meeting on August 24.